An Easy Way Out

~ jtimothyhoward

Last week Fannie Mae and Freddie Mac completed their fifteenth year of conservatorship. By any definition or measure, they have been “conserved.” Their combined net income over the past 20 quarters (or five years) has averaged $25.0 billion per year, and the extremely high credit quality of their current $7.56 trillion books of single- and multifamily mortgages (close to half of the $15.9 trillion in residential mortgage debt outstanding) enabled them to survive the 38 percent drop in home prices assumed in their 2023 Dodd-Frank severely adverse stress tests without the need for any initial capital. The only reason they remain in conservatorship is that neither Congress nor any administration has made it a priority to confront and resolve two policy decisions made over a decade ago—agreeing with what I call the Financial Establishment that Fannie and Freddie must hold 4 percent-plus “bank-like” capital irrespective of the risks of the mortgages they guarantee, and the August 17, 2012 agreement between Treasury and the Federal Housing Finance Agency (FHFA) to change the dividend on the companies’ Treasury senior preferred stock from 10 percent per year to “an amount equal to the incremental increase in [their] net worth during the immediately prior fiscal quarter,” known as the net worth sweep.  

The decisions to deliberately overcapitalize Fannie and Freddie and impose the net worth sweep (preventing them from retaining capital by moving $242 billion from their balance sheets to Treasury’s coffers between December 31, 2012 and June 30, 2019) were made at a time when the consensus goal of policymakers was to “wind down and replace” them with some unspecified alternative assumed to be superior. No such alternative emerged (or indeed exists), yet the net worth sweep and gross overcapitalization of Fannie and Freddie persist, and in fact were “hard wired” into January 2021 letter agreements between former FHFA Director Calabria and former Treasury Secretary Mnuchin, specifying that neither can be released from conservatorship until they hold “tier 1 capital” (core capital, less junior preferred stock and a percentage of their deferred tax assets) equal to 3.0 percent of adjusted total assets. Combined, Fannie and Freddie were short of this “release point” by a staggering $382 billion at June 30, 2023, because their tier 1 capital was a negative $133 billion due to the net worth sweep, and 3.0 percent of their adjusted total assets ($249 billion) is far higher than warranted by the risk of the mortgages they finance. The net worth sweep and Treasury’s liquidation preference also block the companies’ access to the capital markets, and even at $25 billion per annum, filling a $382 billion capital shortfall with retained earnings alone would leave them in conservatorship for another 15 years.  

It may well be, however, that the net worth sweep and the companies’ overcapitalization both experienced “tipping points” on Monday, August 14. That day a jury hearing the case of Berkley Insurance Co. versus FHFA (formerly Perry Capital versus FHFA) in the United States District Court for the District of Columbia found that FHFA “wrongly amended” the Senior Preferred Stock Purchase Agreements when it agreed with Treasury to impose the net worth sweep, and awarded damages of $612.4 million (to be paid by the companies). August 14 also was the deadline for comments on FHFA’s request for input on Fannie and Freddie’s capital and pricing, and the submissions from the most influential and respected voices in the industry were sharply and persuasively critical of the structure and capital requirements of the Enterprise Regulatory Capital Framework (ERCF), made final by Calabria in December of 2020. The jury verdict in the DC District Court easily could prod Treasury to focus more intently, and analytically, on an “exit strategy” from a dilemma with the net worth sweep of its own making, while the chorus of criticism about the excess amounts of conservatism and non-risk-based elements in the ERCF will make it difficult for FHFA to continue to ignore the blatant inconsistency between the capital required of Fannie and Freddie by the ERCF and the results of their annual Dodd-Frank stress tests.

Of the two impediments to the companies’ exit from conservatorship, the net worth sweep is the more important, and has been the more intractable. From the time the sweep was imposed on Fannie and Freddie, Treasury has insisted that it was designed to benefit them by preventing a “death spiral” of borrowing to pay the 10 percent after-tax dividend on their outstanding senior preferred stock, and also that it was fair compensation for having saved them from failing during the financial crisis. Many (including me, in an amicus curiae brief for the Collins case decided at the Supreme Court in June of 2021) have pointed out that the facts do not support Treasury’s version of and justification for the sweep, to no avail. But the August 14 jury verdict in the D.C. District Court will be harder for Treasury to ignore, and it also opens the door for more “truth telling” about its and FHFA’s treatment of Fannie and Freddie, most notably the internal memos among senior Treasury officials admitting that they did know Fannie and Freddie were about to enter a period of “golden years of earnings” because of the reversal of their non-cash expenses, and that Treasury intended the net worth sweep to keep them from retaining those earnings to recapitalize. While these memos were not admitted as evidence in the Berkley Insurance case because Treasury was not a defendant in it and the judge ruled them to be hearsay, the memos do exist, and they will be very difficult for Treasury to defend.

The posture of Treasury on the net worth sweep during the Biden administration has been to ignore it. This Treasury has no prospect of receiving any income from it, because of the clause in the January 2021 letter agreements permitting Fannie and Freddie to retain their earnings, with equal dollar increases in Treasury’s liquidation preference, until “the last day of the second consecutive fiscal quarter during which [they have] had and maintained capital equal to or in excess of all of the capital requirements and buffers under the Enterprise Regulatory Capital Framework,’’ at which point the sweep will be turned back on. But that will be far in the future. In the meantime, since both of Treasury’s options for ending the sweep—converting the companies’ senior preferred stock to common stock, or deeming the senior preferred to have been repaid with a 10 percent dividend (as it has been) and cancelling it—carry potential market or political consequences, the easiest and simplest thing for Treasury to do about it has been nothing.

Until now. The jury verdict in the Berkely Insurance case, and a likely follow-up spotlight on Treasury’s true motivations for imposing a net worth sweep that has kept Fannie and Freddie in conservatorship for 15 years, and could do so for another 15 years, changes the risk calculus on Treasury’s attempting to “stick with its story” about the sweep indefinitely. Treasury knows it has not been telling the truth about the sweep, even if the media and the public do not, and sooner or later someone there (or at a senior economic policy level outside of Treasury) will realize that the surest way to avoid getting caught in their false story is to end the sweep. And as they then begin to investigate alternative ways to do this, it will become apparent to them that there is an easy way out of both the net worth sweep and the conservatorships that demonstrably produces the best result for all stakeholders—the administration, Treasury, the mortgage finance system, homebuyers, and investors. 

Senior economic officials (whether in this administration or a future one) first will have to agree on the desired status of Fannie and Freddie once the conservatorships are ended. There really are only two options: returning them to their former states of shareholder-owned companies—ideally with agreed-upon utility-like return targets as a condition of their release, and reasonable capital requirements that allow them to price their business on an economic basis—and formal nationalization. With the latter option, the net worth sweep and Treasury’s liquidation preference could stay in place, but neither political party favors nationalization. That means the only realistic option for Fannie and Freddie’s future requires the sweep and the liquidation preference to be eliminated. Treasury is more likely to embrace this reality when it understands that there is a politically acceptable way to do so that allows it to maintain its pledge to get maximum value on behalf of taxpayers for its “investment” in the companies, while also restoring their access to the capital markets.

Treasury has three types of claims on Fannie and Freddie: (a) warrants for 79.9 percent of their shares of common stock outstanding on a fully diluted basis on the day of exercise, which today would be 4,688 million shares of Fannie common and 2,584 million shares of Freddie common; (b) holdings of senior preferred stock of $120.8 billion in Fannie and $72.6 billion in Freddie, and (c) liquidation preferences of $185.5 billion for Fannie and $111.7 billion for Freddie as of June 30, 2023, increasing each quarter with their net income. Setting aside whether all of these claims were properly or deservedly awarded (by Treasury to itself), what jumps out about them is that their aggregate potential value dwarfs the companies’ current book and market values. At June 30, 2023, Fannie’s book value (or net worth) was $69.0 billion, while Freddie’s book value (net worth) was $42.0 billion. More significantly, both companies’ market values—that is, their share prices times their fully diluted shares of common stock outstanding—are far lower; at their September 8 closing stock prices, Fannie’s market value was only $4.3 billion and Freddie’s market value only $2.2 billion, for a combined aggregate value of $6.5 billion.

The challenge Treasury has in getting what it thinks to be fair value for its claims on Fannie and Freddie, therefore, is that today the market puts a price-earnings (P/E) multiple of just 0.26 on their $25 billion in annual earnings, compared with a P/E of 25 times earnings, nearly 100 times greater, for the average stock in the Standard & Poor’s 500. And there is no mystery why. It’s because of what Treasury (also FHFA, but mainly Treasury) has done to the companies since 2008. From (i) requiring FHFA to put them in conservatorship when each exceeded their statutory capital requirements, to (ii) throwing them “concrete life preservers” of senior preferred stock at a 10 percent after-tax dividend, repayable only with the permission of Treasury (which has never been given), that Fannie and Freddie could be forced to take by having FHFA load up their income statements with anticipated or estimated non-cash expenses, and then (iii) with FHFA, imposing the net worth sweep the moment those non-cash expenses ran out and began to reverse, turning into a torrent of what otherwise would have been retained earnings, Treasury has treated the companies with a unique degree of antagonism and unfairness.

As Treasury evaluates ending the net worth sweep and allowing Fannie and Freddie to exit conservatorship, it will need to determine which of its claims on them have the most value. And that will not be hard. To get value out of its $120.8 billion of senior preferred stock in Fannie and $72.6 billion of senior preferred in Freddie, Treasury will have to convert them into each company’s common stock. Yet the very act of doing so will reinforce investors’ strong views of unfair treatment. They know Fannie and Freddie have repaid their senior preferred, with dividends; it’s just that Treasury has used its non-repayment provision as a reason not to count net worth sweep remittances as repayments. Treasury’s insisting that its senior preferred be converted to common would be requiring the companies to repay their senior preferred twice. If it does, how many investors would choose to buy Fannie or Freddie common stock again—including the stock Treasury would need to sell to get value from converting its senior preferred—and how much would they be willing to pay for it?

Now consider the alternative: making Treasury’s warrants for 79.9 percent of Fannie and Freddie’s existing common stock more valuable by making the companies more valuable. Here, Treasury would work with FHFA and the administration’s senior economic team to negotiate a recapitalization and release agreement that includes retroactive cancellation of the non-repayment provision of the senior preferred and a recasting of the companies’ remittances under the net worth sweep as repayments of the senior preferred stock (which would pay all of it off for both). Fannie and Freddie, in return, would agree to accept utility-like return targets on their credit guaranty business, benefitting homebuyers. Then, for its part, the administration would acknowledge the criticisms made by commenters on FHFA’s request for input on Fannie and Freddie’s capital and pricing, and strongly encourage (or require) FHFA to remove the excess and unwarranted conservatism in the ERCF, to have it more closely reflect the true risks of Fannie and Freddie’s business.

Splitting the difference between the negative 13 basis points of total assets required by the companies’ 2023 Dodd-Frank severely adverse stress tests and the ERCF’s risk-based capital requirement for them at June 30, 2023 of 3.72 percent of adjusted total assets (or 4.08 percent of total assets) would put their required capital at about 2.0 percent. While that’s very likely too low for FHFA to consider (even though it would be over four times the 45 basis points required on the companies’ credit guarantees prior to the financial crisis), the recommendations I made in my comment to FHFA on its request for input, and in Capital Fact and Fiction, are not: first, to drop the “prescribed leverage buffer” Calabria added to the 2.5 minimum capital requirement FHFA set for the companies in its 2018 capital standard, and then remove enough of the non-risk-based minimums and buffers in the ERCF’s risk-based component to reduce it to below the 2.5 percent minimum, which would become the companies’ binding capital requirement for the foreseeable future.

At June 30, 2023, minimum capital for Fannie and Freddie of 2.5 percent of total assets (not “adjusted total assets,” a measure contrived by Calabria that FHFA should drop) would be $189.4 billion. And with their senior preferred stock deemed to have been repaid, their adjusted total capital would jump from a negative $99.5 billion to a positive $101.7 billion, leaving a capital shortfall of $87.7 billion, compared with $408 billion were the net worth sweep and the ERCF to be left as they are.

A capital gap for Fannie and Freddie of only $87.7 billion, along with $25 billion in annual earnings, will give Treasury, FHFA and their and the companies’ financial advisors a lot to work with in devising a viable plan for recapitalizing and releasing Fannie and Freddie relatively quickly, and returning them to a position where they once again could provide properly priced mortgage credit to low- and moderate-income homebuyers on a large scale. As an interim step, they could be released under consent decrees upon completion of initial equity offerings of specified dollar amounts (to reach a target capital percentage), with each then being allowed to decide what mix of retained earnings, additional offerings of equity, and issuance of noncumulative junior preferred stock to employ to eliminate their remaining capital gaps, and obtain relief from all elements of their consent decrees.

Developed and announced as a package, such a plan also would give the market a reason to fundamentally reassess the valuation of the companies’ common stock—and the value of the warrants Treasury would need to exercise before any new issuance of equity by Fannie or Freddie could take place—for the first time since the conservatorships were imposed. Where that value might end up is not easy to predict, given the history of the companies’ ill-treatment by Treasury and FHFA over the last 15 years, which won’t be forgotten even if the regulators do right by them going forward. Still, their valuation has tremendous room for improvement from today’s average P/E ratio of 0.26:1—barely 1 percent of the S&P 500—and there are benchmarks from prior periods as to where that relative P/E might go.

I was Fannie’s CFO during throughout the 1990s, when it established a record of consistent and predictable earnings and a reputation for prudent management of its interest rate and credit risks. Reflecting this, its P/E relative to the S&P 500 rose from about 55 percent at the end of 1990 to about 85 percent at the end of 1998. Then, after FM Watch was formed in early 1999, relentless (and false) criticisms of the company caused investors to become increasingly concerned about its “political risk,” and by the time I left at the end of 2004 Fannie’s relative P/E had fallen to about 45 percent. Today the company’s earnings and risk management are even better than in the 1990s (and it’s not taking interest-rate risk on nearly $1 trillion of mortgages in portfolio), leaving its main risk as political. Thus, if this or a future administration turns around on the way it treats Fannie and Freddie, even given the history of the past fifteen years a P/E relative to the S&P 500 of 50 percent would seem to be attainable, and one higher than that would not be out of the question. A relative P/E of 40 percent would put the market value of Fannie and Freddie at around $250 billion, which would be split among Treasury, existing shareholders, and whatever new investors are needed to help the companies meet their new, more reasonable, capital requirements (with Treasury’s percentage being inversely related to the amount of new equity issued).

Fannie and Freddie’s $25 billion in annual earnings, high-quality books of business, and results of their last three years of Dodd-Frank stress tests highlight the fact that there is no reason for them to have been kept in conservatorship for 15 years, and certainly none to keep them there for another 15 years. The net worth sweep and the unreasonable capital requirements of the ERCF prevent the companies from getting out on their own. But here, the August 14 verdict against FHFA in the Berkley Insurance case involving the sweep and the pointed criticisms of the ERCF in response to FHFA’s request for input on Fannie and Freddie’s capital and pricing give the current administration, or a future one, legitimate reasons to question both. Whichever one does will discover that there is an easy way out of the conservatorships that is a win for all parties—the administration taking the action, its Treasury, the mortgage finance system, homebuyers, and the new and existing investors that supply the private capital Fannie and Freddie need to carry out their missions.

63 thoughts on “An Easy Way Out”

  1. @ROLG,

    Can you help me understand what the “Allocation Plan” issue is in Lamberth’s court? Why is it in dispute? What are the implications?

    Cheers,
    Justin

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    1. @juice

      haven’t been following the case closely enough to comment. I am not confident enough in Lamberth’s understanding of Delaware corporate law to spend the time, and will only focus on appeals, if any.

      rolg

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  2. Tim,
    F&F JPS prices and Commons are movin’. Quite a bit.
    Fundamental? Head fake? Y/e Tax related? Discounting a Trump Presidency? Biden’s Team movin’ behind the scenes (perhaps more apropos Bernstein, Thompson, Yellen, et al)?
    Not looking for any market call, but if these sharp moves are indication of anything you see on your side ‘justifying’ these moves &/or that Biden’s Team perhaps moving b4 an expected Trump win (based on polls)?
    TIA & Merry Christmas & a Happy New Year to All…..VM

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    1. I haven’t heard or read anything to suggest that this week’s moves in Fannie common and preferred (I didn’t check Freddie, but assume its shares moved comparably) were related to any actual or rumored activity on the conservatorship front. And given the timing, it seems likely that this is just year-end window dressing (although why PM’s would want to show Fannie or Freddie on their year-end statements is a mystery–perhaps some that had a bad year want to have an excuse for it….).

      Also, I’d note that the phrase “movin’ quite a bit” is relative. Yes, if you look at a one-week or a one-month chart of FNMA, Friday’s price change was a big move. But to put that into perspective, click on “max.” What you see there is a sharp climb from around $1.50 in 1985 to an average of around $70 between 1998 and 2004 (when Frank Raines and I were forced out by OFHEO), then a free-fall starting in the fall of 2007–when the private-label securities market melted down–that continued until the conservatorships. Since then, for over 15 years, the line is essentially flat, with a few ripples, like you’d see on a pond on a windy day. I don’t know why the wind is blowing now, but that’s probably all it is.

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        1. ROLG–Since I don’t trade either of the share types, I won’t be the “one” to try to plot the two variables you note, to see if the correlation you posit is in fact significant. And even if there is, one still is has to predict the PredictIt odds to predict the price of the preferred shares….

          Happiest of Holidays to All

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  3. Will Biden do ‘anything’ substantive regarding F&F in the next two quarters, if so, what is ‘likely’ to happen, or put another way, NOT likely to happen?

    IF Biden’s Team kicks-the-can, & then loses the November Election (assumption), then what could the Biden Team do ala Trump in the ‘lame-duck period’ between the Election Day and January 20th, 2025?

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    1. VM–I have not read or heard anything that would indicate that the state and fate of Fannie and Freddie are being discussed among the senior economic policymakers in the Biden administration, but that doesn’t rule out the possibility that discussions on this issue might be taking place behind the scenes. As I’ve said often, returning the companies to their former states of shareholder-owned companies, with capital requirements that allow them to set their guaranty fees on an economic basis to the benefit of lower-income borrowers (whose share of loans guaranteed by Fannie and Freddie has plunged since the conservatorships), should be a “wheelhouse” initiative for a Democratic administration that claims to support affordable housing. And as I detailed in my current post–which was written with the administration’s senior policymakers, and those who know or might influence them, in mind (and that I know has been circulated widely)–there IS in fact “An Easy Way Out” of the Fannie and Freddie conservatorships that would be a win for all stakeholders, and for which the Biden administration could take credit.

      Will they embrace that way out? I wish I knew. But “kicking the can down the road” won’t result in a better resolution than the one I’ve proposed, and it WILL result in some other administration getting the credit (and the value of Treasury’s warrants for 79.9 percent of the companies’ common stock) for whatever that resolution ultimately turns out to be.

      I will continue to be on the alert for clues that suggest something might be stirring within the Biden administration’s policy circles. Absent such clues, however, I have no basis for speculating what may or may not happen with Fannie and Freddie, either before or after the election, irrespective of which way it goes.

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      1. Tim

        as for being alert for clues in POTUS land, and its effect on the patience of investors (my principal orientation), let me contrast the GSEs with a somewhat comparable situation, MBIA. MBIA has essentially been a zombie stock for a decade, not conducting business (writing financial guarantees for third party municipal issuers, a business not entirely dissimilar to the GSEs) and husbanding its balance sheet and running off liabilities (most prominently its exposure to Puerto Rico bonds) until such point that it could essentially liquidate…and if one’s calculations are right, return proceeds to investors much greater than its depressed trading price (yes, zombies are not loved by the investment markets).

        so the game with MBIA was patience, and waiting for its management to work through the litigation and regulatory landscape to arrive at a point where the excess value of its balance sheet could reward investors. this was a process subject to speculative analysis.

        this took about a decade…and MBIA was able recently to see itself clear to declaring a large extraordinary cash dividend to investors. for an investor gauging how long this resolution process would take, there was some precedent…leading investors to believe that an end would come even as it wasn’t clearly in sight.

        with the GSEs, there is a similar roadmap, patience…but the guideposts on this roadmap are much more uncertain. the litigation process has largely reached its end without result (or even a whimper). so if one is left to assessing political tea leaves, determining when a political turn of events will occur that will lead to conservatorship exit is more an invitation to magical thinking than analysis.

        it is important to hold an investment in the GSEs with clear eyes and deserved cynicism.

        rolg

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        1. ROLG–I completely agree with you as to how to think about Fannie and Freddie common and preferred shares as investments, although admittedly my situation is different from that of most current owners of these shares. I did not acquire my shares in Fannie Mae as a reaction to the conservatorships or the imposition of the net worth sweep (so there is no aspect of “I’ve got to be right on my investment thesis eventually” to my holdings). After I was forced out as Vice Chairman and CFO of Fannie at the end of 2004–as a result of accusations of financial improprieties by FHFA’s predecessor agency, OFHEO, which after almost eight years of litigation were found by a DC District Court judge to have been false–I was advised by counsel that I should not sell any of the shares I’d earned as compensation until the company had completed its earnings restatement mandated by OFHEO. That did not happen until the fourth quarter of 2006. I owned only Fannie common, and I then began selling it on a programmatic basis, but stopped in the summer of 2007, when the stock showed what I then thought was temporary weakness. (I knew that Frank Raines and I had left the company in good shape to weather the PLS-induced storm that was coming, and was more surprised than most when I heard on BBC TV, while sailing in the Adriatic off Croatia, that Treasury Secretary Hank Paulson had publicly announced Treasury’s commitment to “supporting Fannie Mae and Freddie Mac in their current form.”)

          I have made only one transaction in my holdings of Fannie Mae shares since that time, and that was to sell half of my common in August of 2009 and invest the proceeds in Fannie’s series N preferred (chosen because it was the last issuance of preferred Fannie made while I was its CFO). After the surprising (and indefensible) ruling by the Supreme Court in the APA claim in the Collins case, I told my readers that I might sell some of my Fannie common if I wanted to offset capital gains with some of my (sizable) capital losses in Fannie, but to date I have not done that.

          My current plan is to hold all of my junior preferred, and probably all of my common (we’ll see) until some administration decides what to do with both Fannie and Freddie. I believe receivership (which would wipe both types of shares out) is not an option, because that would cause too much disruption in the market. My view is that all of my holdings of Fannie and Freddie shares will someday be worth much more than they are today–because the underlying business of the companies is so strong–but I don’t know when, and I don’t know how much.

          Finally, I do plan to continue to keep this blog going, but don’t know how many new posts I’ll put up, because I’ve now pretty much said all I have to say, and don’t like repeating myself. If readers are looking for a refresher of my theses, I’d recommend two posts in particular. The first (which can be found under the “Top Posts” heading on the right-hand side of the page) is “A Political Problem,” which gives a summary of what I think the problem with Fannie and Freddie is (and is not), and the second is the current post, “An Easy Way Out,” which is my proposed solution to the problem. Two more good posts to bookmark (also under “Top Posts”) are “An Unexpected Ruling,” which addresses the Supreme Court’s ruling on Fannie and Freddie mentioned earlier, and also contains a link to the amicus brief I wrote for the case, which is the most comprehensive piece I’ve done on the true facts of Fannie and Freddie’s conservatorships and the net worth sweep, and finally a post from 2017 called “A Pattern of Deception,” which uses documents produced in discovery for a case in the Court of Federal Claims to demonstrate that Treasury knows that that its public story about what it’s been doing with Fannie and Freddie–which it has persisted in telling to this date–is false.

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  4. Tim or ROLG,

    Given that it seems the plan would be to redo the ERCF, and in a quick fashion to avoid a lot of pushback from the financial establishment (maybe that is less of an issue these days), given the rules for federal rulemaking, would it be possible for a new final rule to avoid a comment period by using a previously proposed rule that already had comments and go directly to a Final Rule? For instance, could FHFA take the Watt rule and do minor tweaks to avoid a full comment period and go direct to Final Rule?

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    1. I’m not familiar with the legal aspects of the federal rulemaking process, but I if it IS possible for FHFA to issue a final capital rule without putting it out for comment I do not believe it would do so, nor would I advise it to.

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    2. @juice

      under the Administrative Procedure Act, agency rules must be adopted after notice and comment. some agencies have resorted to issuing “guidance” without notice and comment, which those agencies claimed to be enforceable and binding. this was administrative overreach and I dont expect it to survive scotus scrutiny.

      rolg

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      1. Tim/juice

        it occurs to me that FHFA stands apart from other agencies in terms of ability to implement agency policy without compliance with the Administrative Procedure Act. FHFA simply has no effective restraint on its activity.

        some agencies do wield regulatory power in a way that is beyond what was intended by the APA, in my view. for example, the FTC has been accused of “rule making by enforcement”. as opposed to publishing rules with notice and comment that seek to broaden the application of the antitrust statutes (which is what the democratic majority on the FTC wishes to do), the FTC simply brings enforcement cases to implement its expansionary view of the reach of the antitrust statutes. this can be a particularly effective strategy when the FTC seeks to enjoin mergers, as the merger parties are incentivized to agree to restrictions that, in the absence of a desired merger, they might resist in litigation.

        now, why do I say that FHFA stands apart from the other agencies in its ability to “rule without rule making”? because the GSEs are in conservatorship with FHFA as conservator under a conservatorship statute that has been recognized by courts to have almost no limitation. courts have construed HERA to permit FHFA to act in its own best interest without the need to show that the act is also in the interest of the GSEs. There is no better example of this than the NWS.

        consider the effect that this conception of FHFA’s power has on the GSEs and their management. FHFA is big brother in effect with respect to anything the GSEs may wish to do (or not do).

        now, typically, oversight power of agency action is wielded ( and constrained) by congress through oversight committees. I talked to a former GC of an executive department who said that when a member of a congressional oversight committee questioned a budgetary line item of the department under its appropriations legislative process, everyone in the department called “mayday” to address the congressional request. just this oversight made that department careful in all of its deliberations.

        FHFA has no effective congressional appropriations oversight and, imo, no effective judicial oversight (see further Collins). So FHFA can regulate as much and as far as it wants by phone call to a GSE executive without having to resort to bothersome rule making. we may never know how far FHFA utilizes this power in practice.

        rolg

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      1. Fannie’s $73.7 billion net worth at the end of the third quarter was $4.7 billion higher than at the end of the second quarter (an increase equal to its third quarter net income), and we also learned this morning that Freddie’s net worth increased by $2.7 billion (also the same amount as its third quarter net income), to $44.7 billion at the end of the third quarter. Those net worth numbers aren’t the most important aspects of these two earnings releases, however.

        It’s tempting to view the increases in Fannie’s and Freddie’s net worth as proxies for how quickly the companies are meeting their capital requirements, but that ignores what’s happening to their required capital. And in third quarter, Fannie’s required risk-based capital rose by $3.0 billion (or 1.6 percent, despite the fact that its adjusted total assets actually fell during the quarter), meaning it only trimmed its capital shortfall by $1.8 billion, while Freddie’s required risk-based capital rose by $4.0 billion (or 3.2 percent, compared with a 0.4 percent increase in adjusted total assets), so that its capital gap WIDENED by $1.0 billion during the quarter.

        What’s going on here? Neither company said anything about this directly, but the rises in required capital almost certainly were the result of reduced capital credits being given to their credit-risk transfer vehicles. Fannie alluded to this in its 10Q, saying that “For our credit risk transfer transactions executed during the first nine months of 2023, a weaker credit profile of the reference pools, the current higher interest rate environment, and investor expectations regarding a slowdown in home price appreciation have generally resulted in either increased premium costs or the retention by Fannie Mae of a higher first loss position compared with similar transactions in the first nine months of 2022.” It makes sense that more expensive CRTs that give less credit loss protection will result in smaller credits to required capital. And, importantly, these trends in CRT coverage are not likely to reverse in future quarters, meaning that we can expect required capital to continue to rise as CRTs give less and less valuable loss protection while costing more (because the credit risk loss transfer market has limited breadth and depth).

        Neither company discloses how much lower their risk-based capital requirements are because of CRT credits, but recently they’ve begun disclosing what loss coverage they currently expect from them. For Fannie, it’s $265 million over the lives of all “freestanding credit enhancements” outstanding, and for Freddie it’s $0.2 billion (it rounds the number). And while Freddie does not disclose the cost of its CRTs, Fannie does. Through the third quarter, those costs have exceeded $1 billion: $678 million for CAS, $306 million for CIRTs, and $101 million for lender risk-sharing. That’s nearly $1.5 billion per year. While both companies’ lifetime credit loss numbers are expected, not “stress loss,” numbers, the woefully bad economics of these loss transference vehicles, coupled with their deteriorating investor receptivity and declining capital credit, make one wonder how much longer either company will keep issuing them. Yet if they stop, their required risk-based capital will go up significantly (although by an unknown amount, because we don’t know how large the CRT credits currently are). This definitely is something to keep an eye on, and it clouds the timeline for Fannie and Freddie reaching full capitalization if the ERCF standard is kept as it is.

        There were other items of note in the companies’ third quarter releases as well. In no particular order:

        (a) Both companies’ net incomes have benefited from a drawdown in their loss reserves this year. Fannie has drawn down its loss reserve by $2.7 billion since the end of 2022, while Freddie’s loss reserve decline was more modest, at $440 million. In each case, the reductions are a result of the relatively new standard for loss reserving–current expected credit loss, or CECL, accounting–which requires the companies to estimate their lifetime credit losses and reserve accordingly. Those lifetime losses depend on future home price changes and interest rates, which of course are unpredictable. Last year Fannie was expecting home prices to fall by 4.2 percent this year, and it boosted its loss reserve accordingly in 2022. But home prices instead have risen, so it’s drawing that reserve back down (as of September 30 it is only 21 basis points of total mortgages). It’s unfortunate that CECL is requiring both Fannie and Freddie to pretend they know what future home prices and interest rates will do in setting their loss reserves, because it introduces unnecessary volatility into their loss provisioning, and hence their net income. But this standard won’t change, so we just have to be aware of the effect it has.

        (b) Both companies booked expense accruals for the jury verdict in the Fairholme case in the DC Circuit Court of Appeals. Fannie recorded an expense of $491.4 million–damages to preferred shareholders of $299.4 million, with pre-judgement interest through September 30, 2023 of $192 million–while Freddie booked an expense of $313 million ($282 million in damages to preferred shareholders and $31 in damages to common shareholders, with no pre-judgment interest).

        (c) Fannie reported that its FHFA assessment fees in the third quarter, at $39 million, were 30 percent above the $30 million it was assessed in the third quarter of 2022, and that for the year to date it had been assessed $118 million, 27 percent more than its $93 million assessment for the first three quarters of 2022. There has been no check on what FHFA could spend since HERA was passed in 2008, but how can FHFA possibly justify an expense increase of this magnitude given the extraordinary “safety and soundness” of Fannie and Freddie currently?

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        1. I was thinking the exact same thing regarding the increase to the FHFA assessment fees, that is quite the increase. And I always found it funny that the FHFA is the only gov’t agency that provides a 401K plan with employer matching contributions in addition to the standard gov’t Thrift & Savings Plan.

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          1. FHFA’s assessment fee for Fannie was the “shiny object” in its third quarter 10Q, but the CRT costs, coverage and capital implications are far more significant, and they’ve received virtually no coverage or attention. This may be another evident problem that everyone will choose to ignore until it blows up (which it will, eventually, if not addressed in time).

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    1. The two senators are from Delaware, and the congresswoman (Lisa Blunt Rochester) is the Delaware representative from Gary’s district.

      Gary sent his letter, with copies of his latest newsletter and my latest blog post, not just to Secretary Yellen but also to FHFA Director Thompson, CEA chair Bernstein and NEC Director Brainard, with a copy to the President (which means his chief of staff Jeff Zeints is likely to see it). Those are the “right people” in the Biden administration who would need to be involved in any effort to release Fannie and Freddie from conservatorship. Only one of them has to decide that this should be an administration priority and take the lead on it, however, which is why I’m glad Gary sent it to all five.

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      1. Yes, and Gary’s district is the entire state of Delaware. We only have one congress person in Delaware we’re so small!

        One of the two senators approached me in the “Biden train station” not too long ago because he noticed we were wearing the same sneakers. We took a couple of photos together, and later on I wished I had asked him about the GSEs, especially since my wife and I met up with Gary in New York that weekend.

        Anyway, I’m encouraged by the visibility and the targeted audience. I think the ratio of reasons to release to negative optics seems to be increasing.

        https://m.facebook.com/photo.php?fbid=1633547940402409&id=100012416556904&set=a.350812568675959&mibextid=qC1gEa

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        1. FHFA does not make formal responses to comments it receives on the proposals it puts out for comment, or to replies to its requests for input (RFIs); it either takes them into account and acts on them, or it does not. In the case of the RFI on Fannie and Freddie’s pricing and capital, I don’t expect Director Thompson to initiate an independent review of their current capital standard, the ERCF, without prodding or direction from elsewhere in the administration. But as I say in the current post, I believe the replies FHFA has received to the RFI, and the jury verdict in Berkley Insurance Co. versus FHFA, have raised the odds of senior Biden administration officials focusing on and tackling the issue of the companies’ conservatorships before the end of the current term. I have no basis for putting a numerical percentage on those odds, however.

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          2. The objective mentioned on page 15 of FHFA’s Strategic Plan for fiscal year 2024 (which began this month) to “Issue a final rule enhancing the Enterprise Regulatory Capital Framework (ERCF)” by December 31, 2023 appears to be a routine formalization of the minor changes to Fannie and Freddie’s capital standard that FHFA set forth in a notice of proposed rulemaking last summer (for “modifications related to guarantees on commingled securities, multifamily mortgage exposures secured by government-subsidized properties, derivatives and cleared transactions, and credit scores, among other items”.) The objective in the plan has nothing to do with whether, or when, FHFA might respond to the comments it received in response to its Request for Input on the companies’ credit guaranty pricing and capital.

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      3. Tim, how does Fannie Mae purchasing MBS help lower mortgage rates? Would it drop rates significantly? What impact would that have on Fannie Mae’s bottom line? Is that not counter to conservatorship as they are undercapitalized ?

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        1. The rate on new 30-year fixed-rate mortgages has risen by about 4.5 percentage points since the end of 2021—from a little over 3 percent then to over 7.5 percent today. There are three reasons for this. First, market interest rates have risen sharply; the Federal funds rate has increased from around zero to over 5 ¼ percent, while the ten-year Treasury has risen from 1 ¾ percent to nearly 4 ¾ percent. Second, interest rate volatility (which affects the value of the option imbedded in fixed-rate mortgages, and thus the spread between Treasury and mortgage rates) also has risen markedly. And third, the Federal Reserve, which had been purchasing agency (Fannie Mae, Freddie Mac and Ginnie Mae) MBS since the end of 2008, and held $2.74 trillion of these securities in April of last year, has allowed nearly 10 percent of its MBS holdings (about $260 billion) to run off since that time.

          Of these three causes of today’s higher mortgage rates, the first (higher market rates) is by far the most important, with higher volatility probably (a distant) second, and the Fed’s running off of its MBS holdings probably third. Allowing Fannie and Freddie to temporarily increase their holdings of on-balance sheet mortgages would only partially offset the third factor, and thus is likely to have only a relatively modest impact on the level of 30-year fixed mortgage rates.

          Moreover, there are three significant obstacles to getting Fannie and Freddie back into the portfolio investment business. The first is that it would be a reversal of a major policy decision made by Treasury at the time of the conservatorships. Treasury had long been opposed (for various reasons, most of which were non-economic) to the companies’ being in this business, enough so that as part of its Senior Preferred Stock Purchase Agreement with FHFA it required Fannie and Freddie to shrink their portfolios by 10 percent per year (later increased to 15 percent), despite the fact that these portfolios were duration matched and throwing off net interest income in excess of 100 basis points per dollar of asset, helping to offset losses from the companies’ credit guaranty business. I would be surprised if Treasury were to reverse its policy on Fannie and Freddie’s portfolio holdings for only a relatively modest expected impact on the level of mortgage rates. Second, the portfolio business isn’t just buying mortgages; it’s also hedging the exposure from doing so, then planning and issuing the debt and derivatives to match-fund the purchases, and rebalancing the debt structure over time to manage their interest rate and option risk. Fannie and Freddie have not been doing this for some time, and can’t just start these processes back up (and staff them) at will. And finally, former Director Calabria’s December 2020 ERCF standard for Fannie and Freddie does not have a risk-based capital component for the interest rate and option risks of a portfolio business (I suspect because banks’ Basel III standard also doesn’t have one); in fact, the ERCF says, “As the Enterprises currently hedge interest rate risk at the portfolio level, and under the assumption that the Enterprises’ hedging effectively manages that risk, the market risk capital requirements [are] limited to only spread risk”. I would be very surprised were FHFA to allow Fannie and Freddie to add $60 to $120 billion in mortgage investments to their balance sheets on the “assumption” that they will be properly hedged, but without a functioning risk-based capital requirement that applies to them.

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    1. Rather than ignore this submitted comment, I thought I would use it to clarify how this blog differs from other internet sites devoted to Fannie and Freddie, and issues related to them.

      After three years of writing it (which I began in February of 2016, after I submitted an amicus brief for Gary Hindes’ suit in the U. S. District Court for the District of Delaware), I stated my goals for the blog as “to serve as a source of objective and verifiable facts about the mortgage finance system in general and Fannie Mae and Freddie Mac in particular; to draw on my experience with and knowledge about these areas to provide informed analyses of current developments in single-family mortgage finance, and to use these facts and my analyses as the basis for offering opinions on mortgage-related issues.” The blog was not intended to be (and is not) a forum in which anyone—irrespective of their subject matter knowledge, experience or credentials—could express their views, offer unsupported ideas on how to fix things, or vent about how unfair the government’s treatment of Fannie and Freddie is. There are other sites for that.

      The individual who submitted the above request, Rodney, also submitted two “cuts and pastes” from one of those sites, which I did not approve, in which people posted comments alleging violations by FHFA of Fannie and Freddie’s Charter Act and a “Separate account” (I don’t know what that is), and objecting to Ed DeMarco’s “illegal tenure” (which has been raised in several dismissed or pending lawsuits) and the “jury’s cross” of DeMarco, and he asked if I will do a post about them. The answer is no.

      I believe that Treasury and FHFA have acted unlawfully in several areas and on several occasions, starting with the conservatorships themselves. I don’t know if I’ve mentioned this elsewhere, but very shortly after September 7, 2008, a security analyst with whom I hadn’t spoken in almost four years (on advice of counsel, since I was fighting the false charges of accounting fraud brought against me by FHFA’s predecessor agency, OFHEO, at the end of 2004) called me to say that several institutional investors were outraged by Treasury’s effective seizures of the companies, and did I know any lawyers they might talk to about taking legal action. I said that I did (I felt I knew half the lawyers in Washington), and put two very well-known money managers in contact with one of them. One of the money managers already had scheduled a meeting to discuss a possible suit when Lehman collapsed. Through the security analyst, I learned this money manager never followed through with his meeting, because with Treasury having been thrust into the role of “savior of the financial system,” that money manager, and his board, felt they would be viewed badly if they filed suit against Treasury as it was engaged in trying to put out the conflagration threatening the system. Thus passed the best opportunity, as I saw it, to “right the original wrong.”

      I tell that story because there is a right time, a right claim, and a right plaintiff to bring a legal action that has a chance of prevailing. The allegations (or complaints) I see being made on chat boards now do not, in my view, meet any of those criteria. I honestly don’t see any issue where a new claim, brought by a plaintiff with standing and the wherewithal to finance the suit, and that is not time-barred by the statute of limitations, has a realistic chance of being successful. And I’ve never been one to howl at the moon.

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      1. Tim and ROLG,

        I hope this doesn’t come across as howling at the moon…but do you have any thoughts on the (unsurprising) Lamberth decision to award simple interest at 5% over the Fed discount rate? It seemed a long time to reach a simple conclusion…but I expected this outcome (even if it *felt* like there was a decent chance no interest, somehow, would be awarded).
        I’m more interested in something that I’m sure I once knew but have forgotten—how the case wound up in the DC Circuit rather than before the Delaware Court of Chancery. Nearly every GSE case in terms of timing and application of the law (from my perspective as a non-lawyer) has been the polar opposite of the way cases seem to run in Delaware’s Chancery, particularly under the incredibly capable and effective Kathaleen McCormick. I understand she’s only been Chancellor for a few years and wasn’t on the court at all when these cases started…but what a dream it would have been to have her overseeing the first GSE case instead of what actually happened.
        I ask this because of the prod this passage from Lamberth’s decision provided:
        In this case, an important feature of Delaware law is Delaware’s preservation of the ancient English practice of maintaining separate primary trial courts for matters of law and equity: the Superior Court and the Court of Chancery. The ‘Superior Court’s jurisdiction relates to all civil causes at ‘common law’” while “the Court of Chancery’s jurisdiction [is] to hear and determine all matters and causes in equity.”

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        1. @djone

          1. when you sue treasury/fhfa, they will have the right to remove to federal court, even if you are only alleging a violation of Delaware law…and most of the questions of law in these cases were federal questions (HERA) which properly belong in federal court in the first instance. the federal court interprets Delaware law when necessary, as best it can. what you haven’t seen was plaintiffs strenuously moving for novel questions of Delaware law to be decided by the Delaware supreme court under an advisory opinion provision in the Delaware law. that would have been most helpful in the Hindes case. this is backseat hindsight lawyering on my part.

          2. It is apparent that plaintiffs in collins should have alleged a violation of the appropriations clause as an independent legal claim, instead as support for the director removal claim. but in any event, no federal judge was likely going to find plaintiffs damaged by the improper director removal or appropriation provisions of HERA. the nexus prescribed by J Alito is a bridge too far.

          3. what is required is the patience of Job. who knew the GSE saga would turn biblical.

          ROLG

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          1. What would the appeal process look like in regards to the allowed theory of damages? I am assuming the reason P’s attorneys wanted Judge Lamberth to clarify if he was rejecting their theory as a matter of law was so that it can be appealed.

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          2. @fnm

            I expect Ps to appeal Lamberth’s opinions as to unavailability of reliance damages and the unavailability of compound interest. both are big dollar questions. the appeal would look like any other appeal of a federal court decision relating to a question of law.

            ROLG

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    1. It’s probably not a great idea to get me started on this….

      In the current post I briefly mention the “relentless (and false) criticisms” of Fannie by FM Watch that began in early 1999, which “caused investors to become increasingly concerned about its ‘political risk’,” and cut Fannie’s P/E relative to the S&P 500 virtually in half over the next five years. Well, those false criticisms were almost entirely leveled at Fannie’s on-balance sheet mortgage portfolio, for which I was responsible. The big banks, the Mortgage Bankers Association (which later would make Dave Stevens its president) and others, including Fed Chairman Alan Greenspan, insisted that Fannie’s portfolio did nothing to reduce mortgage rates (I still have everyone’s quotes to that effect) and at the same time created enormous exposure to “taxpayers” from the interest rate risk we allegedly were taking (the portfolio was duration matched and continually rebalanced, and we reported on its duration gap each month). And you might remember that the first thing Treasury did after asking FHFA to put Fannie and Freddie in conservatorship was to require them to cut the sizes of their portfolios by 10 percent per year (later increased to 15 percent per year), even though those portfolios were extremely profitable (they remained duration-matched throughout the financial crisis), throwing off over 100 basis points per dollar of assets that helped to offset the companies’ credit losses.

      As it turned out, their portfolios DID make a difference in holding down mortgage rates, which is why very shortly after Fannie and Freddie started shrinking them the Federal Reserve began to build up ITS portfolio of agency MBS. Starting at zero in late 2008, those agency MBS portfolios peaked at over $2.7 trillion last spring (the largest Fannie and Freddie’s ever got, combined, was around $1.5 trillion). And guess what? The Fed didn’t hedge its holdings at all–it funded them by crediting reserve accounts at banks when it purchased MBS in the market, and it pays a short-term interest rate on those reserves. That worked great when the interest rate on reserve balances was 15 basis points–as it was up until last March. But it’s now 5.4 percent. And I would imagine that the weighted average note rate of the Fed’s agency MBS holdings isn’t much different from that of Fannie’s outstanding MBS, which at June 30, 2023 was 3.15 percent. Thus, in a year and a half, the Fed has gone from making 300 basis points on its short-funded agency MBS portfolio to losing 225 basis points. And it’s real money. Through June 30, 2022 the Fed reported 6-month earnings of $63.4 billion; through June 30, 2023, it reported a LOSS of $57.4 billion. That’s a swing of $120 billion in one year, which some might call an “enormous loss to taxpayers.”

      So, the Fed is now slowly running down its agency MBS portfolio–it was just a tad under $2.5 trillion last week–and, as this is happening, we’re now hearing from Fannie and Freddie’s former critics, saying, “gee, it would be nice if you could get back into this business again.” Would you like some irony with that?

      Today, Fannie and Freddie only hold mortgages in portfolio if these loans are “incidental to their credit guaranty business,” per Treasury and FHFA’s requests. Having put the portfolio restrictions in place these two agencies could relax or remove them, but it’s up to them. We’ll see if they do. And also whether they learn a lesson about the value of Fannie and Freddie to the mortgage market (which they don’t seem to have done during 15 years of conservatorship).

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  11. Hi Tim, thanks for an excellent, pragmatic article.

    Might it work to not eliminate the SPS, but instead do a “reverse-NWS”? The SPS could be amended to say “any return ABOVE a utility-like fixed rate of say 10% goes to treasury? And in return, the SPS amount stays as a official commitment from Treasury to protect the mortgage market in any crisis. This would eliminate any incentive for GSEs to be “reckless” in their business, yet make sure the companies are attractive to Investors.

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    1. The senior preferred stock structure you’re proposing would not be classified as regulatory capital, leaving the companies’ tier 1 and adjusted total capital in negative territory. That’s a disqualifier.

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  12. Tim

    great job, per usual.

    from the political peanut gallery, here’s my two cents: the GSE conservatorship presents progressives with cognitive dissonance (and whatever POTUS may actually be thinking on any given day, the ones doing the thinking in his administration are decidedly progressive).

    on the one hand, enhancing housing finance is a progressive good. on the other hand, releasing a private corporation from total federal control is progressive anathema.

    so there is no question the GSEs should be released. we will just have to wait for an administration that will look at the situation without ideology.

    rolg

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    1. ROLG–Since you’ve made many valuable substantive contributions to this blog over the years, I have put my red card (for a comment I view as overtly partisan) back in my pocket, and exchanged it for a yellow. But two yellows do make a red (and we’re playing a very long game here….)

      Of course, both parties have their ideologies. What to me is important in the current context is that, as you point out, there is a conflict between competing tendencies within the Democratic party: to be supportive of entities like Fannie and Freddie who facilitate the provision of mortgage credit to those who might not qualify for it from companies driven purely by the profit motive, and a belief that more government influence over private entities is better than less. But I don’t think the latter necessarily dominates the former. I believe the most important drivers of the Biden administration’s lack of engagement on Fannie and Freddie’s interminable conservatorships are inertia and a lack of knowledge. I can’t do anything about the first, but I can try to help overcome the second. And that is the purpose of the current post.

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  13. I GREATLY appreciate Tim’s expert and forthright portrayal of all this FNMA background and options. I detest Treasury’s long-standing deception and injustice against all players except government. I’ve owned FNMA many years and want out – fairly.  … David Russell

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  14. Tim,

    Thank you for the informative article. I hope this gets shared to all relevant parties to this issue today.

    I noticed you mentioned this administration, or a future administration, would be in position to solve this issue. Given that we are about to enter an election year, do you believe there’s any hope left for the Biden admin to take prompt action on the GSEs, or this is more of a 2025-2028 admin issue?

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    1. As I’ve said before, I don’t know that anyone in the Biden administration is focused on Fannie and Freddie, but if there is it would likely be at a senior level at either the National Economic Council or the Council of Economic Advisors, not FHFA or Treasury, and whatever work they are doing would be behind the scenes. And, no, I wouldn’t rule out the Biden administration acting on this next year. I think it would be a smart political and policy move, that would be broadly supported by the public. That said, though, I have no basis for putting a probability on action along the lines I recommend before the election.

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  15. I see a few late comments have arrived on the Enterprise’s Single Family Mortgage Pricing Framework. Citizens and NAHREP in particular seem to both be advocating to maintain the status quo keeping them in conservatorship and ignoring returns.

    https://www.fhfa.gov/AboutUs/Contact/Pages/input-submissions.aspx

    Citizens states that it aligns with MBA and HPC with some differences. It appears that their goal is for G-fees overall to be as high as possible (presumably so they can price their products as high as possible) by having 10% returns as a minimum floor on capital while maintaining the current ERCF. They complain about GSE status giving F&F an unfair advantage.

    NAHREP seems to advocate for the status quo, or formal nationalization, by indicating that debate on a target rate of return is the wrong question and stating, “Congress created the Enterprises and taxpayer resources now support them.”…” Fannie Mae and Freddie Mac should seek to continue to be financially viable entities and operate as public utilities to facilitate secondary market transactions in a market-efficient way for the benefit of consumers, not as profit-seeking private companies delivering shareholder value. ”

    Is it bad news that FHFA even allowed the late submissions that are counter to the others submitted? It seems like they are seeking out a different narrative than most other commenters advocated. Or are they just allowing the comments because they acquiesced to some political pressure.

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    1. I had read the comment letter from NAHREP (National Association of Hispanic Real Estate Professionals), which came in only two days late; the one from Citizens Bank–a small regional bank in Virginia– was posted on the 25th, so I hadn’t seen it. Letters from neither, however, are much of a counterweight to the letters from informed and influential entities like the Urban Institute, the Center for Responsible Lending and the National Association of Realtors. I also don’t see any negative “thumb on the scale” from FHFA in putting comments up on their website that came in after the deadline.

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  16. Excellent summary. Thank you, Tim.

    My only suggestion would be to point out that the GSEs could be required, as part of the agreement to remove them from conservatorship, to lower their guarantee fees on EXISTING mortgages, saving homeowners with a GSE-backed loan hundreds of dollars a month through lower mortgage payments. This (if it is even possible; I don’t know enough to say) would be a huge political win for any administration exiting the GSEs’ conservatorship. That alone should help persuade politicians that freeing the GSEs is a worthwhile decision.

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    1. Jeff–That was not my end of the business, but I suspect it would be very hard, if not impossible, to retroactively lower the guaranty fees on over 40 million existing mortgages (the approximate number held by Fannie and Freddie). When I was there we set fees at the pool level, and if that’s still the case someone would have to figure out which borrower got what amount of the fee reduction, and then scale that by loan size and remaining amortization to turn it into dollars of monthly payment (and also make sure some loan servicers didn’t keep the fee reductions themselves). That’s a daunting task, and probably not doable. I think lowering fees going forward–based on the new capital requirements and agreed-upon utility-like return targets–is the best that can be done, and still would be a significant political win for whichever administration could claim that as a result it produced.

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  18. In my reading of Calabria’s book “Shelter from the Storm”, Treasury seemed hesitant to convert SPS to anything that would be “more junior” than the JPS (presumably to stay the most senior in the capital stack). Is there a potential “3rd option” whereby UST converts it’s 79.9% warrants and modifies the current SPS obligations in exchange for some kind of “insurance guarantee” annual payment in perpetuity? That way Treasury gets value from its warrants plus the SPS. Also, if they convert the SPS to commons would they not run up (potentially) against the debt ceiling as Treasury’s ownership stake would go above 79.9%? Just curious if that would realistically be a barrier to an “SPS cramdown scenario”.

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    1. I believe there are many arguments against converting Fannie and Freddie’s senior preferred stock to commons, which should become apparent when Treasury focuses seriously on an exit strategy from the net worth sweep (which I think it has to at some point). Whatever it may want to do with the senior preferred, it has to exercise its warrants for the companies’ common stock first, as the market expects. When it does, it will own 79.9 percent of each company. What should it do then? The point I try to make in my post is that if Treasury deems the senior preferred to be repaid and eliminates the liquidation preference, it has a very good chance of getting a P/E multiple much higher than the current 0.26 to 1 on the 79.9 percent of the Fannie and Freddie common it needs to sell to get value from them. But if it converts the senior preferred to common in an attempt to get close to full ownership of the companies, it will (a) be mainly diluting itself, as owner of 79.9 percent of the common, and (b) be giving investors in Fannie and Freddie a very strong reason to keep their P/E anchored close to its current dismal level, to the detriment of all investors in their common, including Treasury. In my view, once the warrants have been exercised, ANY attempt to get value out of the senior preferred will work against Treasury’s best interests. (As to the alternative of Treasury canceling the warrants—and also not converting the senior preferred—I think that’s unrealistic, and if pressed for would result in many more years in conservatorship until the companies can meet their capital requirements with retained earnings, at which point the net worth sweep will be turned on again, keeping both their common and junior preferred stock prices severely depressed.)

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  21. It almost appears that the gorilla in the room is invisible. Nobody is interested
    in dealing with it, even though they know its there.

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  23. An excellent and concise explanation of where we stand and where Treasury should ultimately go. Perhaps with the new higher interest rate mortgage world we now live in and the increased challenges for first time home buyers and Affordable Housing pressures the next Administration (post 2024 elections) will finally address the GSEs

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