Tucked away in Fannie Mae’s third quarter 2023 10Q were three factoids about what has been happening with its credit-risk transfer (CRT) programs since short- and long-term interest rates began increasing in the spring of 2022. The first was Fannie noting, “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 had earlier said, in its 2022 10K, that “Taking into account the increasing cost of these [CRT] transactions, the resulting capital relief, and the credit risk transfer market capacity, we have chosen to increase the first loss position retained by Fannie Mae compared with prior transactions.”) Second, Fannie revealed that through September 30, 2023, the annual cost of its CRT programs had reached an all-time high of nearly $1.5 billion, while the lifetime expected value of its “freestanding credit enhancement receivables” had fallen to just $265 million, compared with $565 million at the end of 2022. And finally, despite a $4.7 billion increase in net worth in the third quarter, Fannie only was able to trim its capital deficit by $1.8 billion, because even with its total assets rising just 16 basis points its risk-weighted assets rose by 2.3 percent, likely caused by diminished capital credit given to its CRTs, due to the company’s taking more risk on recent issuances.
I have been a long-time critic of Fannie and Freddie’s CRT programs, which began with a directive from the Federal Housing Finance Agency (FHFA) in its 2012 Strategic Plan for Enterprise Conservatorships to “[shift] mortgage credit risk from the Enterprises (and, thereby, taxpayers) to private investors,” and since that time has led FHFA to give annual targets or directives to both Fannie and Freddie for credit-risk transfer securities (CAS and STACRs, respectively) issuance, and insurance/reinsurance (CIRT and ACIS) transactions. The essence of my criticisms of these programs—particularly CAS and STACRs—is that the companies pay far too much to insure high-quality books of business against losses that have only a remote chance of occurring, and that investors will not buy new CRT securities during periods of financial stress, when they are most likely to be of value to the issuer.
I thus was very pleased, and surprised, when in May of 2021 FHFA itself released a report titled Performance of Fannie Mae’s and Freddie Mac’s Credit Risk Transfer that not only agreed with my observations and conclusions but also offered data in support of them. The report first gave the economics of the companies’ CRT programs to date: “As of February 2021, the Enterprises had paid approximately $15.0 billion in interest and premiums to CRT investors and counterparties and the Enterprises had received approximately $0.05 billion via investor write-downs and counterparty reimbursements.” (That’s $1 of benefits for every $300 in premiums.) But it was the simulations of future CRT performance done by FHFA—using the residential mortgage model of a consulting firm, Milliman—that were the real eye-openers. FHFA ran both a “Baseline” and a “2007 Replay” scenario. In the Baseline scenario, Fannie and Freddie’s lifetime CRT costs were $33.60 billion and their “ultimate benefits” were $1.06 billion ($1 of benefits for every $32 in premiums), while in the 2007 Replay the lifetime CRT costs were $30.72 billion and the ultimate benefits were $10.10 billion ($1 in benefits for every $3 in premiums).
Those results weren’t just non-economic, as I had been saying, they were staggeringly non-economic. And I kept waiting to see what FHFA would say about them. But all it said was, “FHFA continues to assess the CRT programs, including their costs and benefits as well as the benefits and risks to the safety and soundness of the Enterprises, the Enterprises’ ability to perform their statutory mission, and the liquidity, efficiency, competitiveness and resiliency of the national housing finance markets.” That made no sense. What could be left to study? In a blog post about this (FHFA’s CRT Report) I wrote, “This encapsulates what’s so wrong with the Calabria-led Federal Housing Finance Agency: they tout themselves as a ‘world-class regulator,’ yet they seem to be operating in a world divorced from reality. Calabria and others at FHFA refer to CRTs as a triumph of ‘bringing private capital into the mortgage market,’ but their staff has put out a report showing the truth to be just the opposite: by requiring huge amounts of annual interest payments while providing minimal absorption of credit losses in return, CRTs siphon tremendous amounts of capital out of the mortgage market, and weaken the companies FHFA regulates.”
We now know from former director Calabria’s book, “Shelter from the Storm,” that he did understand that Fannie and Freddie’s CRTs were huge wastes of money; but instead of eliminating the FHFA directives and capital incentives to the companies to issue them, he blamed Wall Street. He said this in his book:
“Once I had established an independent research and evaluation function within the FHFA, I asked that team to evaluate CRT performance…. Unfortunately, that analysis was not completed until after the capital rule was finalized. I was stunned by the results. As the housing market had been mostly strong during the use of CRTs, I certainly expected to see short-term costs exceed short-term benefits. But I was not expecting the efforts to have a net cost of around $15 billion. That is real money. The analysis included stress test results as well. Most shocking was that if we again experienced a 2008 scenario, the net costs would go up, not down. [Note: that’s actually not true.]
The clearest way to think about CRT is as insurance. You pay premiums, and if something bad happens, the insurance covers the cost. Yet the way that CRT worked was that you paid massive insurance premiums and then when something bad happened, your coverage would immediately expire [note: that’s also not true] and you would get almost nothing back….It slowly dawned on me that the CRTs were structured to almost never pay.
In the late spring of 2021, after it became apparent that the companies had essentially been looted, we started to investigate the details of how CRT transactions were underwritten. Our first shock was learning that the Wall Street underwriters earned fees that were multiples of the net values of CRTs to the companies. These Wall Street underwriters—you can guess the firms—were supposed to protect Fannie and Freddie, but instead they joined in robbing their clients. Of course, the CRT investors, primarily hedge funds and real estate investment trusts, were also clients of these Wall Street firms.
We had just begun putting the pieces together when the Collins decision…was made and my tenure came to an end. Given the connections between the Biden administration and the Wall Street players profiting from CRT, I suspect that any investigation has come to an end. In fact, one probable reason the Biden administration wanted me out so quickly was to end it.”
Calabria’s self-depiction as the thwarted potential savior of Fannie and Freddie from the evil CRTs devised by Wall Street does not withstand even the most superficial scrutiny. (A more likely explanation is that, as a longstanding ideological opponent of the companies, he was perfectly content to leave the money-losing CRT programs in place, while blaming Wall Street and a Democratic administration for not ending them.) And in any event, the initial visible responses of FHFA to its May 2021 CRT report were to (a) increase (not reduce or eliminate) the capital credit given to CRTs in the revisions to the Enterprise Regulatory Capital Framework proposed that September and made final later, and (b) change the CRT language in the companies’ 2020 and 2021 Scorecards saying “Continue to transfer a significant amount of credit risk to private markets in a commercially reasonable and safe and sound manner” to “Transfer a significant amount of risk to private investors, reducing risk to taxpayers” in their 2022 Scorecard. (The deleted clause “in a commercially reasonable and safe and sound manner” was restored in the 2023 Scorecard, perhaps because no one had noticed its absence in the Scorecard for the previous year.)
Short- and long-term U.S. interest rates began to rise sharply in the spring of 2022, about a year after the work on FHFA’s CRT report—which covered the period between Freddie’s and Fannie’s first CRT issues (in July 2012 and October 2013, respectively) and February 2021—had been completed. And since that time, the issuance environment for CRTs has deteriorated dramatically. So as bad as the economics of the companies’ CRTs issued from 2012 (or 2013) through 2020 were, the economics of the CRTs issued from 2022 to now, and for the foreseeable future, almost certainly will be worse. FHFA has been silent on this, and Fannie only hints at it, but the reasons are straightforward, and are manifested in the changes to the structures and costs of the CAS issued by Fannie over the past two years.
Before getting into the details of some of these securities, it’s helpful to lay out a framework for the analysis. Fannie’s CAS and Freddie’s STACRs are structured as senior-subordinated securities. After (usually but not always) an initial amount of credit losses absorbed by the issuer, at some level of credit loss rate, say 50 basis points, the owner of the most junior CAS or STACR tranche begins to absorb the issuer’s credit losses, up to a “release point,” say 140 basis points. Then, the owner of the next most junior tranche begins to absorb losses, up to its release point, say 250 basis points. A CAS or STACR structure typically will have one or two additional loss-absorbing tranches, covering losses up to anywhere between 350 and 550 basis points, at which point any remaining losses fall upon the issuer again.
A second important feature of CAS and STACRs is that each tranche is priced at a spread over 1-month SOFR (the Secured Overnight Financing Rate, formerly LIBOR, the London Interbank Offered Rate). SOFR is a floating rate that moves closely with the federal funds rate, and this always has been a weakness of the CAS and STACR structures. Just as funding a portfolio of 30-year fixed-rate mortgages with short-term debt will lead to narrowing margins or losses when short rates rise, buying credit insurance on pools of mortgages that have fixed guaranty fees using floating-rate CRTs will make the cost of that insurance go up when short rates do, with the CRT issuer having no way to offset that extra cost with higher revenues. Up until the spring of 2022 this unfortunate feature was muted by the fact that 1-month LIBOR or SOFR averaged less than 100 basis points during the 2012-2021 period; it was under 20 basis points during five of those years, and only exceeded 200 basis points in one year, 2019 (topping out at just over 250 basis points). Recently, though, the story has been different. One-month SOFR crossed the 300 basis-point threshold in October of 2022, rose above 400 basis points that December, and now stands at 5.35 percent. The forward yield curve for 1-month SOFR has it staying above 3.00 percent for the next several years.
A much higher SOFR is only one of the challenges facing CRT issuers. Higher mortgage rates also have reduced activity in the housing market, caused slower home price growth, and led CRT investors to require higher spreads over SOFR on the CRTs they buy. With higher SOFR base rates and increased spreads over SOFR required by CRT investors, the only way Fannie (or Freddie) has to keep any control over the cost of its CRTs is to insure a lesser percentage of its credit risk, and that’s what it has been doing.
There is no such thing as a standard CRT structure, and the interactions of their component parts are very complex. But there is a fairly reliable metric that gauges the efficiency of Fannie’s different CAS issuances, and a combination of three good metrics that track their costs. The efficiency metric is the percentage of the first 250 basis points of credit loss transferred to CRT buyers. (The reason for the cut-off at 250 basis points is that nearly all CAS issues transfer at least that percentage of credit losses, and losses in excess of it are increasingly unlikely.) The three cost metrics are: (a) 1-month SOFR at the time of pricing, (b) the weighted average spread over SOFR of all CAS tranches (the amount of each sold tranche times its spread to SOFR, divided by the total dollar amount of the sold tranches) at the time of pricing, and (c) the initial cost of the CAS in basis points (SOFR plus the weighted average spread times the dollar amount of the sold tranches, divided by the size of the mortgage pool these CAS issues are insuring). None of these measurements are perfect. The efficiency metric ignores where within the 250 basis-point range the losses are transferred, while all three cost metrics can, and do, change over time (including the weighted average spread over SOFR, which rises as the more senior, lower-spread tranches pay off). But the metrics do offer insight into what has been happening with Fannie’s recent CAS issues.
Prior to the pandemic, Fannie consistently had been able to cover 76 to 86 percent of its first 250 basis points of credit losses on CAS-insured pools by limiting its first-loss position to between 25 and 50 basis points, and retaining only 5 percent of the tranches above that level, on which it paid an average tranche spread to SOFR that rarely exceeded 250 basis points. When the company resumed CAS issuance in the fall of 2021, it stayed with this low first-loss retention (at that time 25 basis points), and with SOFR at just 5 basis points and the weighted average CAS tranche spread staying under 300 basis points, Fannie’s initial pool cost on its first four post-pandemic CAS issues was less than 8 basis points. Short- and long-term interest rates began rising in March of 2022. Fannie stayed with the same basic structure for the CAS it issued on April 5, 2022, but paid an average spread of 413 basis points over SOFR (at 29 basis points), for an average pool insurance cost of 14 basis points. Then, as interest rates continued to rise, the CAS Fannie issued on June 28 with only 30 basis points of initial loss retention required a weighted average tranche spread of 502 basis points, and with SOFR at 1.52 percent the company had to retain half of its two most junior CAS tranches (on which it paid 1200 and 680 basis points over SOFR, respectively) to hold its initial pool insurance cost at 28 basis points.
With an average net guaranty fee (total guaranty fee less 10 basis points paid to Treasury and 8 basis points of administrative expense) of 44 basis points on new business, Fannie could not continue to pay 28 basis points for CRTs that, per FHFA’s own admission, provide very little credit loss protection during periods of stress. Something had to give, and what gave was the amount of first-loss exposure Fannie kept. In the CAS it issued on September 21, 2022, Fannie created two tranches it retained that took the first 125 basis points of credit losses, and it also retained 75 percent of the next most junior tranche, which took the losses between 125 and 190 basis points. Keeping this much of the credit risk allowed Fannie to lower the initial pool cost of that CAS to 12 basis points, but at the expense of only being able to able to transfer 29 percent of its credit losses up to 250 basis points—with none being transferred until Fannie had absorbed the first 125 basis points of those losses.
SOFR continued to rise through the summer of 2023, and as it did Fannie’s CAS issuance became an exercise in tailoring the amount of the first 250 basis points of loss exposure it retained in an effort to keep the initial cost of each issue around or below 30 basis points of the total pool size. In its final two CAS issues of last year, Fannie retained 150 or 155 basis points of first-loss exposure, then an average of half the exposure in the next tranche, which covered losses to over 250 basis points. With those issues, the CAS program became the numerical opposite of what it had been before the pandemic (and FHFA’s 2021 CRT report): instead of transferring 76 to 86 percent of its first 250 basis points of credit losses to CAS investors, Fannie was retaining 76 to 86 percent of those losses, while paying an average of 21 basis points for the remaining (miniscule) loss protection CAS investors were willing to provide at that price.
Fannie’s CAS program has never been economic, but it’s now a charade. The company seems to have set an average initial pool cost it will accept (although the cost of individual CAS issues can vary considerably), and it keeps as much of a mortgage pool’s credit risk as it has to in order to sell CAS at that price, with the percentage of transferred credit losses being the variable. There is not even a pretense of these issues being effective or efficient.
This, of course, is not Fannie’s fault; it is another stupefying consequence of the company’s conservatorship under FHFA. The former director of FHFA, Mark Calabria, has admitted that CAS are a “looting” of Fannie, yet knowing this, the current director, Sandra Thompson, continues to use both carrots (capital credits) and sticks (CRT issuance goals that reduce executive compensation if not met) to encourage CAS and STACR issuance, even as the costs of these deals soar and their benefits dwindle, making the looting even greater.
The only explanation for FHFA’s passivity in the face of the CAS charade is the same as for its passivity in addressing the inconsistency between the results of its recent Dodd-Frank stress tests and its regulatory requirement that Fannie and Freddie hold 3.0 percent capital before they can be released from conservatorship: the current FHFA leadership will not make any significant change to the status quo for the companies—no matter how obvious, urgent or desirable—unless or until it is directed to do so by some other institution or individual, whether Congress, Treasury, or a very senior economic or policy official in the administration. In the meantime, the losses from their CAS and STACR programs will slow the growth of Fannie and Freddie’s retained earnings, while the reduced capital credit given to their much less efficient new CRT issues will be a headwind against filling their capital gaps, by causing their risk-weighted assets to rise at a faster rate than their total assets.
HOWARD ON MORTGAGE FINANCE 
Tim
Two artifacts of conservatorship are the Treasury funding commitment (Treasury is obligated to fund as much as $113.9B if Fannie Mae’s net worth goes negative) and Treasury’s $120B senior preferred stock.
I say artifacts inasmuch as Fannie’s current net worth of $82B makes the likelihood of an imminent draw on Treasury’s funding obligation remote, and Treasury’s $120B senior preferred stock balance no longer provides for current distributions. It is worthless from a cash flow perspective.
These are relics from a prior GSE financial repression regime. Treasury no longer needs its senior preferred stock (having been fully repaid with 10% interest under the NWS), and Fannie no longer needs its Treasury line of credit. Time for spring cleaning.
Wy wouldn’t the Biden administration and Fannie simply cancel the two artifacts, in a consensual deal giving up an unnecessary asset for the elimination of an unnecessary liability, each of uncertain value.
Why would the Biden administration do this? It just might convince the finance-challenged West Wing to realize that Treasury’s warrant position is actually worth >$100B. That would no doubt surprise a few West Wing politicos. Even Treasury, preoccupied with policing sanctions and raising enough money to pay our fiscal deficit, might see the benefit too.
Or am I conceding too much credit where no credit is due?
ROLG
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ROLG– I want to comment briefly on your statement that “Treasury no longer needs its senior preferred stock (having been fully repaid with 10% interest under the NWS), and Fannie no longer needs its Treasury line of credit.”
Re the senior preferred stock (SPS), the problem the Biden administration has (and that any future administration will have) is that the SPS does have value, in that (thanks to the Supreme Court’s decision in Collins) it allows the government to reclaim the right to all of Fannie and Freddie’s future net income once they attain full capitalization. I personally believe that this value was the reason former Treasury Secretary Mnuchin ultimately was not willing to cancel the senior preferred when there were so many market rumors that he was about to–he didn’t want to face the criticism of “giving away the rights to the companies’ net incomes for nothing.”
The SPS line of credit is more subtle, but also problematic. When I was Fannie’s CFO, there was no question in my mind that Fannie’s federal charter was interpreted by foreign central banks and many other international investors as conveying an implicit government guaranty of its debt and mortgage-backed securities (MBS), which is why these instruments were eligible for purchase in unlimited quantities, and traded at very low option-adjusted spreads over Treasuries. Fannie and Freddie’s placement into conservatorship called into question the manifestation of that implicit guaranty, and the senior preferred stock agreement (SPSA) appears to be its new incarnation. Were I advising the government, I would tell it to be very careful about jettisoning the SPSA when releasing Fannie and Freddie from conservatorship. If the companies lost federal agency status as a consequence of no longer having some evident “special relationship” with the U.S. government, the impact on the costs of their debt and MBS–and their business model in general–would be severe, if not catastrophic.
I think these two “vexing problems” with the senior preferred stock and the SPSA are why the Biden administration has not taken the two simple steps you recommend (and I have recommended often in the past). Whichever administration initiates a process to remove the companies from conservatorship will need to have a specific and articulated rationale for doing so, that it can use in defending its actions and choices against critics. I thought the Biden administration had a clear opening to use Fannie and Freddie’s return to financial health–demonstrated by their ability to survive the last two Dodd-Frank stress tests with no need for any initial capital–and the obvious degree of excessive conservatism in former Director Calabria’s risk-based capital standard to argue that it was in the best interest of the American mortgage finance system and housing affordability to cancel the net worth sweep and Treasury’s liquidation preference, give Fannie and Freddie a true risk-based capital standard that allows them to price their credit guarantees on an economic basis, and keep in place the PSPA but charge a risk-appropriate fee for it. The fact that it has shown no signs of doing this suggests that Biden’s top economic officials either are unaware of the real facts about the companies’ risk and financial health (and instead remain captive to the myths promulgated about them by their critics and competitors), or are unwilling to incur the criticism that would certainly come from the Financial Establishment were they to call out the fictions told about the companies for what they are, and to defend canceling the SPS as an essential step in restoring Fannie and Freddie to a position where they could resume their prior positions as the primary sources of large-scale, low-cost mortgage financing for low- and moderate income homebuyers.
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Tim
Well put, per usual.
As to “Whichever administration initiates a process to remove the companies from conservatorship will need to have a specific and articulated rationale for doing so…”, I think any investment banker retained to analyze Treasury’s financial options going forward would, when asked which scenario would afford a more prompt execution of maximum financial value, respond with the scenario involving the cancellation of SPS, exercise of warrants and resale of the warrant shares into the market once the GSEs have consummated primary offerings and listed their common stock back on a national exchange.
The only natural holder of the SPS is the government. While the SPS “has value”, it is not a cash flow instrument currently, and (I would argue) the rights afforded by the terms of the SPS are more easily defended in court going forward by Treasury, as provider of the line of credit, than some future private party with no contemporaneous financial support obligation.
The much cleaner exit for Treasury would be to realize value from the sale of the shares realized upon exercise of the warrants than from sale of the SPS.
ROLG
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Tim,
It would be great to get your take on this recent Whalen article (https://www.theinstitutionalriskanalyst.com/post/gse-release-really-update-ally-financial) and some thoughts on Whalen’s history with this. In the past he’s often seemed to have an agenda, but he makes some pretty specific claims in this article that require your expertise to address.
Thanks in advance for any counter arguments or clarity you can provide.
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I’ve seen countless articles like this one by Whalen over the past 25 years (since the formation of FM Watch, when Fannie and Freddie’s opponents and critics began publishing pieces using out-of-context facts and misinformation to “explain” why the companies either were much riskier than commonly believed, or provided little real benefit to homebuyers).
In the article above, almost all of Whalen’s “pretty specific claims” flow from dubious statements he makes at the outset. Without supporting evidence, he asserts: “Since 2008, legal and regulatory changes make it impossible to pretend that the GSEs are sovereign credits once they leave government control. If a once and future President Donald Trump were to move to release the GSEs from conservatorship, Moody’s and the other rating agencies would be forced to downgrade both credits. Think ‘A+’ including the Treasury credit line….The second issue preventing a release of the GSEs is operational, but also goes to value. Both GSEs have deteriorated operationally over the past 15 years, losing any operational efficiency in favor of a culture that is more like the U.S. Postal Service with an angry progressive overlay. Under the Biden Administration, Fannie Mae and Freddie Mac lost most of the key personnel with actual mortgage market experience that enabled them to be competitive.”
The gratuitous comment about operational efficiency disqualifies Whalen as a reliable analyst of the companies. There have been no reports of operational issues at either Fannie or Freddie from any objective source, and the erosion of their competitiveness is entirely due to their guaranty fee pricing, which has been artificially and unnecessarily elevated by grossly excessive capital requirements. And that links to Whalen’s first misstatement, about credit. He asserts that were the companies to be released from conservatorship the ratings agencies would reduce their credit ratings to A+ “including the Treasury credit line,” and that this “is when the trouble would begin.” The facts, however, suggest otherwise.
To begin with, Whalen probably does not know that Standard and Poor’s gave Fannie a “risk-to-the-government” rating of AA- back in 1997, when most of the company’s earnings came from its on-balance sheet mortgage portfolio business, and it held 3.72 percent capital against its total assets, NOT including outstanding mortgage-backed securities, which were held off-balance-sheet (and against which it was required to hold minimum capital of 45 basis points). Today, Fannie’s MBS are all on its balance sheet, its much riskier on-balance sheet mortgage portfolio makes up just 1.3% of its total mortgages financed (on-balance-sheet mortgages accounted for 35.4% of Fannie’s mortgages financed in 1997), and its total stockholder’s equity at December 31, 2023 was $77.7 billion, or 1.80% of its total assets, virtually all of which (95%) were guarantees of mortgage-backed securities, which in 1997 had minimum required capital of 45 basis points, or one-quarter of the capital it holds today. So why, Mr. Whalen, would Fannie be given a worse “risk-to-the-government” rating today than 27 years ago? Because you would like that to be the case?
Then there is the “inconvenient fact” that both Fannie and Freddie have been able to pass their last two Dodd-Frank stress tests–assuming a repeat of the home price declines that followed the Great Financial Crisis–with no initial capital at all. Most responsible proposals for releasing Fannie and Freddie from conservatorship admit that some form of formal support for the companies (as is the case now, with the Senior Preferred Stock Purchase Agreement) would remain in place, but be paid for. And the current SPSPA requires that its commitment fee be “mutually agreed by Purchaser [Treasury] and Seller [Fannie or Freddie], subject to their reasonable discretion and in consultation with the Chairman of the Federal Reserve.” As long as the companies’ Dodd-Frank stress test results remain anywhere close to where they currently are, the chances of them ever having to rely upon Treasury support are minuscule, and a “reasonable” commitment fee would reflect that. Again, that’s not the result Mr. Whalen desires or predicts, but it’s what should happen based on the facts.
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Thank you, Tim.
I struggle to understand every article Whalen writes. He makes unsubstantiated statements followed by statements like “Wow” “Can’t make this stuff up.” As though what he wrote made any sense whatsoever. I never see the connections he is implying. Does he know anything about how the mortgage market works? Why do people read his posts or acknowledge his existence? He just seems to be saying nonsense with his opinion attached. I don’t see any expertise behind his articles. Do you think he is knowledgeable but deliberately misinforming or do you think he he doesn’t understand the things he is writing about? I feel like an idiot because I don’t understand him at all and yet he gets press. Not sure if that is just my ignorance about how things work.
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I don’t know Whelan, and don’t want to say or imply anything about his knowledge, expertise or motivation for writing the articles he writes. I will say, though, that the bar for writing critical pieces about Fannie and Freddie is very low. Opponents of the companies know that there is a wide audience for articles critical of them, that is generally (and often completely) uninformed and thus receptive to almost anything negative that is said about them. And the financial media virtually never rebut or refute misinformation printed about Fannie and Freddie, so there is no corrective mechanism in place to prevent misstatements or outright falsehoods about the companies from perpetuating. It has been that way since the conservatorships, when Fannie and Freddie were “discouraged” from speaking out on their own behalf.
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Tim,
I would appreciate any comments you might have on the following passage from Mark Calabria’s book:
“Congress meant for the companies to be a backstop. For that reason, both companies’ charters require them to conduct their business, especially in terms of pricing, in a way to ‘discourage excessive use of their facilities.’ Congress intended them to be the mortgage buyer of last resort, not first. It was as clear as day in the law, even if it had been ignored for decades.”
Thanks!
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Anyone who has followed Calabria’s statements or writings knows that he believes Fannie and Freddie should be “the mortgage buyer of last resort, not the first.” He has all but said that this philosophy is the reason he put so many cushions, buffers, add-ons and elements of conservatism into the companies’ risk-based capital standard–so that their pricing would be non-competitive during normal times, and then be the “only game in town” after his preferred lenders (deposit-based banks) pulled out of the market during times of stress.
But I think he is stretching to infer that Congress intended this when it chartered Fannie and Freddie. You’ll note that Calabria does not give the legislative context of the directive to “discourage excessive use of their facilities.” I’m not going to search through Fannie’s charter looking for this phrase, but I suspect it’s a mere exhortation against overextending themselves, and in any case Congress certainly did not mean the companies should price their business unnecessarily and uneconomically high (as Calabria has caused them to do with his capital standard), thus artificially raising the cost and reducing the availability of the only product (residential mortgages for low- moderate- and middle-income homebuyers) their charter permits them to deal in.
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Calabria is on record that he wishes there was no such thing as securitization…which is tantamount to wishing for the return of the 3-6-3-days of local small banks taking deposits at 3%, lending out mortgages at 6% and holding to maturity (the spread!), and hitting the golf links at 3pm.
“Congress meant…” Well, a body of 535 individuals doesn’t mean anything but the words they chose, and these words over time have spawned multi-trillion secondary mortgage finance entities, certainly resulting in lower interest rates than would obtain in their absence, as bankers started to forego their afternoon tee times and realize that there is more money to be made originating and selling than originating and holding (and golfing).
Libertarians and small government types do have their charms, but titling at trillion dollar windmills is not one of them. To think that he was FHFA director overseeing the GSEs is like having Carrie Nation serving drinks at your local gin mill.
ROLG
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Calabria’s appointment as Director of FHFA put him in a position to use the agency’s capital setting authority as a means of creating cement boots for Fannie and Freddie to accomplish his ideological objective of reducing their abilities to carry out their chartered purposes. A Director of FHFA appointed by Biden could have undone this damage, but the instantaneous response of the Financial Establishment to the impending naming of Mike Calhoun to that position–causing his nomination to be put on hold, and ultimately leading to the appointment of Sandra Thompson, who has been a dutiful caretaker of the status quo since taking office–has resulted in the ideological constraints put on Fannie and Freddie by Calabria far outliving his (unfortunate) tenure. It is very disappointing that the Biden administration has allowed this to happen.
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Tim is too thoughtful to say this, but I will.
Sandra Thompson is an “empty suit” and has been such ever since she was appointed.
Despite her FHFA title(s) before being Peter-principled to agency Director, over superior other candidates, she never had any history of being a “houser,” i.e. someone who supports deeply making it easier for families/individuals to buy a home and build equity and–as most owners do–enhance the neighborhood by enhancing property values, spending in/with local stores and businesses, voting more often and, and becoming more civically active, enjoying all of the positive things homeownership produces.
Instead, she has become an obstructionist, when not being a tool for big banks, the MBA, and the many mortgage banking affiliates.
The good news/bad news is that without the Treasury or WH support, Ms. Thompson can’t do anything except to continue to endorse Calabria’s actions.
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Tim
go to minutes 23:50-24+ of this video, to see Brainard respond that exit from conservatorship is not being considered by Biden administration: https://x.com/DoNotLose/status/1767715237568921625?s=20
ROLG
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ROLG–I’m not surprised by this. Five days ago, when I learned that the Biden administration had announced what it called a “Plan to Lower Housing Costs for Working Families”–and Fannie Mae’s component of it turned out to have been an order to FHFA director Sandra Thomson to remove the block she had imposed on an insignificant Fannie pilot program to allow “seven or eight” lenders to waive title insurance requirements on a “relatively small number of mortgage financings”– I wrote, “[T]his small publicized action on title insurance very likely also is a large silent message that the administration is not currently considering tackling the much bigger issue of removing Fannie and Freddie from conservatorship this year.” Yesterday, Brainard simply “said the silent part out loud.”
My analysis of that decision by the Biden administration hasn’t changed from what I wrote in my comment five days ago (below). But it IS disappointing. The judicial road to getting Fannie and Freddie out of conservatorship was shockingly blocked by Justice Alito’s strained and indefensible ruling on the net worth sweep in June of 2021. Brainard just signaled that the Biden economic team feels the administrative road is too dangerous to travel, and of course, given the dysfunction in Congress today, the legislative road is an overgrown, barely-visible, cowpath.
In my comment of March 8, I said that getting Fannie and Freddie out of government control was “complicated, opposed by the Financial Establishment, and too arcane for either the administration or the media (who have paid no attention to any of the facts about Fannie and Freddie for a decade and a half) to explain to the public.” This last fact, in my view, has now become the impediment that must be overcome for any action to be taken to remove the companies from conservatorship before they’re able to qualify for removal themselves, under the punitive conditions agreed to by ex-FHFA director Calabria and ex-Treasury Secretary Mnuchin in January of 2021 (which would take at least another decade). Or to say it directly, the consequences of having Fannie and Freddie run by government bureaucrats (e.g., the deliberately money-losing CRT programs that result in lower-income homebuyers subsidizing wealthy Wall Street investors) and grossly overcapitalized (so that they have to set their guaranty fees at non-economic levels, pricing affordable housing buyers out of the market or driving them to the FHA, which last year, for the first time in modern history, financed more mortgages that either Fannie or Freddie did) have to become so blatantly obvious that some influential person or body, somewhere, notices and says, “Oh, I think there’s a problem here; we’d better fix it!” How long this might take is anybody’s guess.
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Let’s see if the Biden Administration holds pat on no administrative action when/if the Trump election threat grows and JB is scrambling to do more than merely announce his intentions to help “more low and moderate income families get into homeownershp (paraphrasing).”
As we’ve discussed, truly functioning, unencumbered GSEs–out from under the Conservatorship yoke–help make that happen and sooner.
And if Biden wins in November and brings either the House or Senate with him, who up there will bitch and what will it matter?
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Tim,
I, unfortunately, agree with your analysis (and did the first time you provided it). Like you, I’m not surprised but am disappointed at Brainard’s remarks and the Biden administration’s position. In fact, I think I might be *more* disappointed.
We–you and I–agree on the reality that the judicial path out of conservatorship is ‘blocked’. But while I share your opinion that the Alito-penned opinion is ‘strained’ and the decision is not one *I* would defend, it was unanimous. This wasn’t a matter of a politicized issue securing a bloc of politically appointed judges to vote according to any particular party’s interests. It was a shutout, 9-0. And, while Gorsuch did ask the question of why the court wasn’t interested in providing a remedy to what it had identified as a constitutional defect, his voice was solitary in making the point. Today’s decision provides cold comfort–he was joined by Jackson, who may have held differently in the Collins case. (As an aside, today’s ruling turned on a linguistic issue nearly as simple as the Collins case’s–‘may’ in Collins, whether ‘and’ should be read disjunctively or conjunctively in the latter). But Sotomayor didn’t even join Gorsuch’s dissenting opinion in Collins. So, while *we* wouldn’t defend the ruling, it is defensible–at least to those 9 tasked with making the call. And, even if it’s not defensible on logical or legal grounds, it doesn’t need a defense at this point, as the opinions of those Justices are the only 9 that count.
More concerning is the reality that FHA has, unthinkably, surpassed Fannie & Freddie in mortgages financed in 2023. Might this cast doubt about another aphorism you’ve often said (and I’ve as many times agreed with): TINA? An administration–one from a party typically far more receptive to Fannie’s and Freddie’s mission than other parties–who would allow conditions to exist in which the FHA does more business in the mortgage market than both F&F would seem to have turned your ‘TINA’ from a truism to a bromide. Let’s hope not.
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The unanimous SCOTUS opinion in Collins is obviously the final word, but I’m sticking with my opinion that it was not defensible. As I wrote at the time in An Unexpected Ruling (accessible on this site in the Top Posts section), it takes a tortured reading of HERA to claim that the authorization for FHFA to act “in the best interests of the regulated entity or the Agency” that appears in a subsection of HERA titled “Incidental Powers” can be read to extend to the statute as a whole, and even then the Court had to pretend that giving all of the companies’ future net income to Treasury somehow was in the best interests of “the Agency” (FHFA). And, to me, the unanimity of the opinion was due to the high likelihood that the six conservative justices were united in their goal of giving their fellow Federalist Society members the “win” over Fannie and Freddie it had been seeking since that society’s founding forty years ago, and none of the liberal justices had enough knowledge of what was a very arcane case to give them any reason to write a (futile) dissenting opinion.
As to “TINA” (“there is no alternative” to Fannie and Freddie), that’s still true; the Financial Establishment seems to have given up trying to come up with alternatives to replace them. What has happened instead is that its support of the status quo for the companies–grossly overcapitalized and burdened by the consequences of the net worth sweep, which over the six and a half years it was in effect (before it was suspended in the third quarter of 2019) pushed them into a huge negative position on their regulatory capital–has caused them to have to operate with non-economic guaranty fees that are unaffordable to the borrowers it was chartered to serve. THAT was what I’d hoped the Biden administration would try to remedy, but for whatever reason it has chosen cheap PR victories for itself over substantive economic benefits for what traditionally has been a core Democratic constituency, low and moderate income homebuyers–at least so far.
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Tim,
As far as I know the Fed still holds nearly $2.4 T in agency MBS. Traditionally, until the 2008 crisis, U.S. Treasuries were their main holdings and “tool” for monetary policy. They announced a plan to sell off $35B or so a month – at that rate it will take almost 6 years to zero them out. One can’t help but think this is at least one factor affecting the c’ship. Do you feel comfortable commenting on this and, if so, do you have any insight into this part of the puzzle? It’s hard to fathom a return to shareholder control if agency MBS are somehow to remain either a significant part of or a permanent fixture in the Fed balance sheet.
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The Fed’s holdings of Agency MBS hit a high of $2.74 trillion on March 23, 2022. After drifting a little lower over the next six months, these holdings have declined fairly steadily since that time, at a pace averaging a little under $17 billion per month. While there may have been some sales, the large majority of this decline has come through amortization and prepayments, without the purchase of replacement MBS. And if the Fed did announce a pace of decline of $35 billion per month at some point (I don’t recall one), it’s only been running its MBS portfolio off at about half that rate over the last 18 months.
I also believe that the Fed’s holdings of Agency MBS aren’t a factor in the decision to keep Fannie and Freddie in conservatorship (or to release them). I do believe that the Fed’s decision to begin buying Agency MBS in 2008 was very much influenced by Treasury’s requirement–after it had directed FHFA to put the companies into conservatorship–that Fannie and Freddie run off their holdings of mortgages and MBS in portfolio, but I don’t believe anyone at a policy level in the administration is seriously revisiting that decision. So if and when the companies finally ARE released, my expectation is that they will remain limited to the credit guaranty business, and be allowed to hold only those mortgages and MBS that are incidental to the running of that business.
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Tim–What do you think of the Biden decision tonight to let Fannie (and I assume, soon, Freddie) offer title insurance to reduce homeownership costs?
Note that last year FHFA Thompson put thumbs down on the idea.
What do you think of them apples, Ms. Thompson?
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Bill–My initial reaction (which hasn’t changed as I’ve thought more about it) was that this small publicized action on title insurance very likely also is a large silent message that the administration is not currently considering tackling the much bigger issue of removing Fannie and Freddie from conservatorship this year.
According to an article in the Wall Street Journal, the title insurance initiative the administration approved was a “pilot program, [in which] Fannie would waive the need for title insurance for a relatively small number of mortgage refinancings offered by seven or eight lenders.” Despite the program’s small size, the title insurance industry lodged an objection with the FHFA (probably viewing it as “the camel’s nose in the tent”), and according to the WSJ, even though the “White House has been pushing the FHFA and other agencies to find ways to lower closing costs…Fannie’s federal regulator, the Federal Housing Finance Agency…ordered Fannie to abandon work on the pilot program amid objections from title insurers and Capitol Hill lawmakers.” Yesterday’s action, which the Journal noted was announced “hours ahead of President Biden’s State of the Union address,” required FHFA to reverse that order.
The Journal reported that “the American Land Title Association, an industry group, criticized the plan as ‘a purely political gesture offering a false promise of savings for homeowners’.” I don’t agree that it’s a false promise, but the actual savings, in the context of all of the closing costs borne by mortgage borrowers, will be imperceptible. But the action got tagged as being “good for consumers,” and allowed journalists to lump it in with other administration initiatives to reduce “junk fees,” such as capping late fees on credit card payments at $8 (which WILL save billions of dollars for consumers nationwide).
And therein lies the problem. Removing Fannie and Freddie from conservatorship and replacing their non-risk-based capital standard with one that will allow them to price their credit guarantees on an economic basis would have an enormously positive impact on low and moderate-income homebuyers, but it is complicated, opposed by the Financial Establishment, and too arcane for either the administration or the media (who have paid no attention to any of the facts about Fannie and Freddie for a decade and a half) to explain to the public in a way that the Biden team will be given political credit for it. So why take on the “hairball” of the companies’ conservatorships if the administration’s key economic policy officials think they can get as many, if not more, political points from announcing the approval of a pilot program that likely will benefit fewer people than can fit on the Icon of the Seas (the new “world’s largest cruise ship”)?
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Thanks ! Your blog is clearly the most informed and neutral commentary on this subject.
I believe that the treasury warrants will be due in 2028- unless I am mistaken. If so what impact would this have on the twins after the next election (regardless of who wins). After all this has been seen by many as a ‘can to kick down the road’. However we are all now older and the current deadline fits into the next administrations mandate. One might assume that the timeline would compel treasury to act in some way or other. However….
Could a future administration actually decide to let the warrants expire with the expectation of taking the twins over entirely or perhaps for some other reason/rationale?
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The warrants for 79.9 percent of Fannie and Freddie’s common stock outstanding at the time of exercise expire on September 7, 2028, at 5:00 pm New York time.
I believe that if nothing is done with them before that date, its impending arrival will serve as a “forcing action” for whichever party controls the White House to finally decide what to do about the companies’ then-20-year-old conservatorships. I think it’s unlikely that the administration in power would allow the warrants simply to expire (they’re too valuable), and equally unlikely that Treasury and FHFA will agree to extend them (too controversial). And when the warrants ARE exercised, I expect it to be done in the context of some defined plan to remove Fannie and Freddie from conservatorship; i.e., I don’t think the administration would exercise the warrants and just sit on the shares.
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Thanks for the reply. So by that measure the Hemingway adage may apply. Something like change occurs ‘gradually then suddenly’. The move from gradually to suddenly will occur when the powers that be realize that time is up.
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The Hemingway quote is from his novel The Sun Also Rises, in which one of the characters, Mike, is asked, “How did you go bankrupt,” and his answer is, “Two ways. Gradually and then suddenly.”
For Fannie and Freddie’s exit from conservatorship, the more apt description for the process will be “glacially and then suddenly.” And I’m hoping that the “suddenly” occurs well before the expiration date of the warrants.
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@pathrik
my own view is there is no timeline imposed by the warrant expiration date. if courts allowed the govt to do the NWS, courts will allow the govt to extend the warrant maturity date, and the govt knows the courts will allow this.
it is all about who is POTUS. Treasury secretaries dont care…Mnuchin evidenced this and Yellen blithely stated it.
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I’ll start by noting that all this is speculation four and a half years into the future, so, as has been said, “the world will little note, nor long remember, what we say here.”
But my view is that the longer Fannie and Freddie remain grossly overcapitalized in a conservatorship they cannot exit on their own because the net worth sweep dug huge core capital holes too deep for them to climb out of before 2040, the more the anomalous “real world” consequences of that indefensible situation will become apparent, and harder to ignore. We already have the annual Dodd-Frank stress tests that show zero required capital for the companies to survive a repeat of the 2008-2012 home price cycle, and we now know that former FHFA director Mark Calabria called their credit-risk transfer programs (that HIS agency was requiring of them) a “looting,” that will eat up an ever-increasing percentage of their pre-tax revenues as they continue. And Fannie and Freddie’s fourth quarter 2023 earnings evinced more anomalies that virtually no one has commented on.
Most important, to me, was that last year, for the first time since Fannie had a mature MBS issuance program (which it began in 1981), Ginnie Mae accounted for a higher percentage of mortgage-related securities issuance (36%) than either Fannie (30%) or Freddie (29%). Over the previous four years, those market share averages had been Fannie 38%, Freddie 32%, and Ginnie 26%. Some of the reason for this huge swing to dominance by Ginnie Mae was the shift from a refi to a purchase money market, but I believe a more significant reason is that Fannie and Freddie now have to price to director Calabria’s ERCF capital standard, whereas the FHA (the underlying loan source of Ginnie MBS) does not.
The impact of the ERCF also is showing up in business growth. Fannie’s single-family book of business actually fell, by 0.8%, between December 31, 2022 and 2023, whereas Freddie’s only grew by 1.8% during this same period. One of the (many) quirks of the ERCF is that Fannie has a much higher capital requirement than Freddie, even though their business risks are virtually identical–at year-end 2023 Fannie’s required risk-based capital was 4.13% of its adjusted total assets (and 4.44% of its total assets), whereas Freddie’s comparable requirements were only 3.50% and 3.66%. Given this differential, it’s not a surprise that Fannie would see more of an impact of excess capital on its business than Freddie.
A final, and more subtle, effect felt by Fannie in 2023 was on the geographic distribution of its loan acquisitions. Since before I became Fannie’s CFO (in 1990), the company always had done a notably larger percentage of its business in the west than in any other of its five regions–and since the conservatorships that share had averaged over 30%. Not in 2023. Only 21% of Fannie’s new business came from its western region last year, less than both the southeast (28%) and the southwest (24%). The west is the country’s least affordable region, and that’s where Fannie’s non-competitive guaranty fees seem to be doing the most damage.
None of these effects are likely to get better–and most are likely to get worse–as long as Fannie remains subject to FHFAs egregiously unjustified capital standards, and remains controlled by its conservatorship. My bet is that there will be a “tipping point” where the damage being done to low- and moderate income homebuyers by the consequences of the status quo becomes too blatant and extreme to ignore, and this will occur long before the expiration date of the warrants. But if not, that expiration will become the “stop sign” that I don’t think any administration will be able to ignore by blithely moving it further into the future, while continuing to pretend that nothing needs to be done about Fannie and Freddie.
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Tim
” I believe a more significant reason is that Fannie and Freddie now have to price to director Calabria’s ERCF capital standard, whereas the FHA (the underlying loan source of Ginnie MBS) does not.”
both very interesting and very little understood/appreciated in DC.
Unsustainable certainly, but often the reason why things that cant go on dont go on is the misery arising from unforced error (or more bluntly, stupidity). as you say, tipping point…but tipping points are often recognized with the benefit of hindsight accessed from the vantage point of one’s surveying the wreckage.
ROLG
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If you or your readers are interested, here’s our appellate brief in the Federal Circuit:
https://drive.google.com/file/d/1Gi-SmKIVT6qFJvUtotvpl8oUre2Oh0IB/view?usp=sharing
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Bryndon– Thank you. I will read this shortly.
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I’ve now had a chance to read the Fisher-Reid appellate brief for an en banc hearing by the full U.S. Court of Appeals for the Federal Circuit on that court’s prior ruling against the derivative claim of a regulatory taking by the FHFA though the net worth sweep, and found it to be well constructed, compellingly argued and persuasive. Although I have an astoundingly poor record at predicting the outcome of legal cases affecting Fannie and Freddie, I thought adding the recent SCOTUS decision in Tyler v. Hennipen Cty. Minn. to the mix gave this brief at least some chance of persuading the Federal Circuit appellate judges en banc to reverse the three-judge panel’s earlier ruling, and find for the plaintiffs. We’ll see.
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I have a family acquaintance who recently left treasury for a job in the private sector. asked him/her about his/her tenure at treasury and what treasury was most focused on.
Answer: Sanctions, sanctions and sanctions.
ROLG
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In the recent House Financial Services Committee hearing, Sec Yellen acknowledged that she is not “knowledgeable” and “not up to speed” about the Treasury’s investment, particularly the possibility of monetizing its warrants, in the GSEs. It is almost unbelievable that she would be not “knowledgeable” about this, but I guess it confirms that the WH has not had any active discussions with the Secretary (or possibly anyone at Treasury) about administrative action.
The comment comes in response to a question from Rep. Fitzgerald at the 4:34:45 mark.
Hearing Entitled: The Annual Report of the Financial Stability Oversight Council (youtube.com)
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I have been saying for some time that if the Biden administration were to create a path for Fannie and Freddie to exit conservatorship prior to this year’s presidential election, the initiative for that would have to come from outside FHFA and Treasury, i.e., someone at the NEC, CEA or potentially the Office of the President. But the fact that Yellen would say she is not knowledgeable about the financial issues related to Treasury’s involvement with the companies is a strong indication that no senior economic official in the administration has yet spoken with her about this, which they obviously would need to do to create a workable exit plan. So that’s not a great sign. The clock is ticking on this, and there is a lot of work that will need to be done in the dwindling amount of time left do it.
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Although Yellen stated that she’s not acquainted with the details of monetization, she indicated that her staff has spent “a great deal of time thinking about this.” It is conceivable to me that there is a green light to get this done before the election and that she will be presented a path out of conservatorship that she merely needs to rubber stamp. I never anticipated that Yellen would be the architect of the capital structure details, which someone like Mnuchin could do in his sleep.
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For there to be a “green light to get this done before the election,” someone in the administration first has to define the “this,” and then get consensus on it. And the “this” isn’t just “get Fannie and Freddie out of conservatorship.” There has to be a more specific purpose, or objective, for getting them out (and it’s not going to be “so that the people who now own Fannie and Freddie common and preferred stock can get rewarded for their perseverance”) that justifies the opposition and criticism that inevitably will come from powerful interests who benefit from the status quo. (An insufficient reason to incur that criticism, by the way, likely was why “Mnuchin [who] could do [this] in his sleep” did not in fact get it done.)
My thesis for why the Biden administration might take on the “tar baby” of the companies’ conservatorships has been that there are clear economic and political benefits that would accrue to it from doing so. It could right the obvious wrongs committed by previous administrations (of both parties) of (a) nationalizing Fannie and Freddie during the financial crisis when they were provably the healthiest entities in the mortgage finance system, after the private-label securities market melted down and the banks stopped lending, next (b) booking non-cash losses on their income statements that forced them to take on massive amounts of senior preferred stock only repayable with Treasury’s permission, and then (c) when those non-cash losses ran out and began to reverse, agreeing to the net worth sweep with FHFA so Fannie and Freddie could not recapitalize. FHFA, under Mark Calabria, subsequently gave them “risk-based” capital requirements that were entirely determined by artificial assumptions (guaranty fees absorb no credit losses), cushions, add-ons and excessive conservatism, which for each of the last three years have proven to have been ridiculously high by the results of the Dodd-Frank stress tests FHFA runs on them. With negative core capital caused by the senior preferred (Treasury’s doing) and capital requirements that are excessively and unjustifiably high (FHFA’s doing), the companies have been consigned to indefinite conservatorships, during which they are forced to charge unnecessarily high guaranty fees (because of their required capital), impeding access to credit by the low- and moderate-income homebuyers they were chartered to serve.
Democratic administrations traditionally have supported government entities that help lower-income people purchase homes they can afford (Republican administrations, on the other hand, have not). Getting Fannie and Freddie out of conservatorship so that they can to return to their traditional missions of providing credit guarantees on an economic basis to their target borrower base should be a “no brainer” for the Biden administration, even without the sweetener of the $100-plus billion it would earn from selling the converted warrants for 79.9 percent of the companies’ common shares at prices that reflect their true market values. Some senior economic official (or officials), however, would need to take the lead on this. As I’ve said many times, it won’t be Yellen or Thompson, but whoever it is would almost certainly need to get those two on board early in the process, given the magnitude of the “calls” involved–what to do about the net worth sweep and Treasury’s liquidation preference (Yellen), and replacing what I call the “Calabria capital standard” with something that reflects the actual risk of the loans Fannie and Freddie are guaranteeing (Thompson). So, to me, the fact that Yellen said at her House Financial Services Committee hearing that she’s not “up to speed” or “knowledgable” on the Fannie and Freddie issue strongly suggests that the project of releasing the companies from conservatorship–which should be a “no-brainer”–hasn’t gotten onto the Biden administration’s priority list yet. And that’s very disappointing, since time is running short.
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I think we will know very clearly what the administration is (or isn’t) intending to do about the GSEs after the State if the Union Address on March 7, 2024. It’s really really tough to talk about the economy without talking about housing. Biden pretty well avoided it last year. If he does so again, it would confirm no one is planning to make a move during this term, in my opinion.
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Relevant to the “The CRT Charade”, this was posted by IMF today:
“GSE CRT Issuance Limited in 2023
The government-sponsored enterprises sharply pulled back on issuance of credit risk sharing transactions in 2023, according to a new ranking and analysis by Inside MBS & ABS.
Fannie Mae and Freddie Mac issued $8.91 billion of CRT transactions in 2023, down 58.8% from 2022. Issuance in 2022 was helped by lingering loans from the refinance wave while mortgage originations were down sharply in 2023.
Christian Valencia, vice president of single-family CRT capital markets at Freddie Mac, offered more details on the GSE’s activity during a recent webinar.
One key factor in the decline in issuance, Valencia said, was Freddie’s decision to shy away from costly B-level tranches, a move he said was part of a strategy to build equity. He noted Freddie now has more than $40 billion in equity compared to near zero just a few years ago. “
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We should learn more about Fannie and Freddie’s 2023 CRT issuance when they publish their 10Ks for that year–as they should do by the end of next week (or very shortly afterwards).
The 58.8% decline in the companies’ CRT issuance last year compared with 2022 is due to three factors: lower originations, a lesser percentage of those originations being covered by CRTs, and the companies’ retaining more of the credit risk on the insured pools. The latter two factors reflect the much worse economics on post-pandemic CRTs that I wrote about in the current post, and I’ll be interested to see in the 10Ks to what degree these contributed to last year’s plunge in CRT issuance.
But to me the most significant aspect of the IMF article (which I hadn’t seen) was the comment from Freddie’s vice president of single-family CRT capital markets, Christian Valencia, specifically citing Freddie’s decision “to shy away from costly B-level tranches” of CRTs. These are the first-loss tranches, and in any given deal there can be as many of three of them. I haven’t looked at Freddie’s CRT issuance, but in Fannie’s last two CAS deals done in 2023, it retained ALL of the first B tranche up to 150 or 155 basis points, and an average of about half the next B tranche, which covered losses up to more than 250 basis points. (That’s definitely “shying away!”) And it was revealing that Mr. Valencia called the decision to issue fewer costly B tranches “part of a strategy to build equity.” Why does not issuing B tranches build equity? Because B tranches lose a LOT of money, by causing Freddie to pay out far more in interest payments than it can ever hope to get in credit loss reimbursements.
Except no one at Freddie will say this directly, because that would be viewed as criticizing their conservator, the entity using what I called in my post “carrots and sticks” as incentives for Freddie (and Fannie) to keep issuing money-losing CRTs. And IMF just reports what Mr. Valencia said (‘we’re building equity”), rather than asking, “Why does FHFA insist that Freddie and Fannie keep issuing CRTs that drain their capital, prolonging their stays in a conservatorship that FHFA has so far refused to release them from, while claiming to be waiting for Congressional action to free the companies that has little if any chance of ever happening?” Here is a ludicrously indefensible activity “hiding in plain sight,” that everyone seems to be unwilling to acknowledge publicly. I wonder how much longer this willful blindness will continue.
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is it possible that hedge funds who are buying these are lobbying to keep the status quo? Or is the complexity wrapper too much for any journalist to cover this? Its quite a scandal at this point. Clearly there are people inside the FHFA that know it’s all a scam based on the profitablity report.
One does have to wonder what is really going on here with these highly non-economic securities.
It could only happen on the watch of a conservator who either is incredibly ignorant or being incentivized to look away. No other choices really.
Another really good reason to get them out of c-ship. Public company CEOs would have a much harder time plundering the companies this way. Wolves in the henhouse.
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It’s indisputable that hedge funds are making a very large amount of money off Fannie and Freddie’s CRT issuance (as are money managers). But the reason Fannie and Freddie are issuing CRTs is because FHFA has made their issuance a performance objective for them, and gives them a (completely unwarranted) capital credit when they do so. It’s possible that the hedge funds are lobbying either FHFA or Treasury (or both) to keep these wasteful programs going, but I know of no evidence of that.
As to the lack of journalistic coverage of the CRT charade, I suspect that general investigative reporters aren’t aware of the issue (and would have a hard time getting up to speed on it), while I fear that the good financial journalists (there still are some) are too concerned about a negative reaction from the Financial Establishment if they’re the ones responsible for “killing the golden goose,” so don’t want to touch it. I got fairly close to getting one of these journalists (who I won’t name) to do a CRT story in the fall of 2021, but for reasons I thought were a little flimsy the story didn’t materialize. I still have that correspondence on my computer, and I may take another run at it, with the facts and observations in my current post (and hopefully some more data and information on the CRT programs in Fannie’s and Freddie’s 2023 10Ks) as the “news peg.”
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*Thanks!
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I wanted to respectfully mention that Dave Stevens has just been reported to have passed away.
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Tim
A very happy new year. Wanted to see if you had any thoughts on the out-of-the-blue Bloomberg article where the FNMA CEO talks about life after conservatorship. This is the first time I am seeing one and specifically HERA cut their wings on this, or lobbying or presser etc
Am I reading too much into this or is there something behind the smoke?
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I hadn’t seen the Bloomberg article until someone sent it to me this morning, and to me it seems fairly clear what the relatively new (since last May) CEO of Fannie Mae, Patricia Almodovar, is trying to do: focus more policymaker attention on the incongruity of keeping Fannie and Freddie mired in interminable conservatorship for no reason. Almodovar is quoted as making three “light touch” comments in the article: (a) “Conservatorship was never meant to be permanent, right?”, (b) “Someone somewhere has not taken a victory lap for the work that has been done to rehabilitate the enterprises,” and (c) “Should they continue to be in conservatorship? What I worry about is do you lose some commercial muscle when you are in this sort of state, right? You’re not government, you’re not the private sector.” None of these comments are critical of either FHFA or Treasury; they’re constructive, with a “what is everyone waiting for” tone. I think that’s the right posture for Fannie to be taking for now. (The more critical comments relating to the companies’ non-risk based, “risk-based” capital standard that ignores the results of the recent stress tests, and requiring them to issue money-losing CRTs, would be too aggressive at this point, and risk backlash.)
To me, the Almodovar comments are a very welcome first step in not allowing the ridiculousness of FHFA’s (and Treasury’s) tolerance of an indefensible status quo for Fannie and Freddie to remain off the public radar. The media refuses to report on this issue unprompted, so who will call attention to it if not Fannie or Freddie? Historically, Fannie always has been more likely to take the lead in situations like this, and it seems that’s what’s happening here. I believe Fannie is looking at the same bleak future for itself as I see if the status quo remains in place for too much longer, including a loss of talent as frustrated employees give up and go elsewhere, and has decided to not just sit back and watch that happen. Good for it. If Fannie keeps up the “what are we waiting for” dialogue–adding in more color, as necessary, on the absurdity of some of the reasons being given for keeping the conservatorships in place–that will make it increasingly difficult for policymakers to continue to pretend that nothing needs to be done to free the companies.
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Thanks for the detailed and elaborate view/response.
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Tim, great post. I couldn’t help but think of the Munger quote, “show me the incentive and I’ll show you the outcome…” when you explain that issuance of the CRTs is a driver of executive compensation. What could go wrong?
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Fascinating post. I had tried to read more about the CRT program, but didn’t get to this level of depth. I knew the CRTs were not economical, but did not realize the scale of how badly these deals were structured. Shame on FHFA for letting this go on.
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VG–It’s not one shame, but multiple ones, earned over the years through a combination of intended villainy and absolute incompetence.
The GOP House claims it wants to stop excessive federal financial regulation. It should closely examine the FHFA and realize that nobody on the Hill oversees the agency.
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I think it has gone just as you predicted.
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Always informative. Thank you.
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Excellent summary of the CRT issue Tim! Is there a way to name names of who is participating on the other side of these CRT transactions? I feel like this is once again a political problem. Someone is lobbying to keep this cash cow going and that theft is what voters hate. Right now voters don’t have anyone to point at as the ‘bad guys’ and FHFA is happy to continue to play dumb just like Calabria did. Is there a list somewhere of the ‘CRT buyers club’? I wish that everyday people like me could invest in these and not just the few blessed by FHFA to rob GSEs and taxpayers. If they opened it up though, I’m sure prices would suddenly get economic.
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Fannie does not give the names of the buyers of its CAS securities (and it shouldn’t), but it does give out considerable information on the investors in its deals by type of investment entity. Over the years, money managers and hedge funds consistently have accounted for around, or more than, 80% of CAS purchases, with money managers buying somewhat more (they favor the more highly-rated, and less risky, tranches, while hedge funds favor the riskiest, and highest-yielding ones). REITs are a very distant third. And CAS buyers are a very small group; according to Fannie’s Single-Family Credit-Risk Transfer investor presentation, dated January 2024, there have been only 267 “unique investors” in Fannie’s CAS since the program’s inception (so it’s not for retail investors). And the lead CAS underwriters are the large U.S. investment and commercial banks; their names, along with all of the members of each underwriting syndicate, are listed in the prospectus for each CAS deal.
But I disagree with your characterization of CAS buyers (and Calabria’s designation of the lead underwriters) as “the bad guys.” The CAS buyers are just buying (and, with the lead underwriters, setting the prices for) what Fannie is selling. The real bad guy is FHFA, who as I note in the post, is using “carrots and sticks” to get Fannie and Freddie to issue CRTs it knows are wildly uneconomic and wasteful. (Treasury also may be a “bad guy,” depending on the extent to which it’s prodding FHFA to keep the CRT giveaways going.)
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Tim
“The real bad guy is FHFA, who as I note in the post, is using “carrots and sticks” to get Fannie and Freddie to issue CRTs it knows are wildly uneconomic and wasteful.”
FHFA, of course, is a fiduciary as conservator, but SCOTUS has made it clear that FHFA can promote the best interests of the GSEs and/or FHFA, at FHFA’s election (due to a tortured reading of HERA). But FHFA would be hard pressed to defend CRTs, given your analysis, as being in anyone’s best interest other than CRT buyers….and I don’t see them mentioned in HERA.
This would be a fascinating corporate waste lawsuit, assuming one could get past the derivative demand of the board requirement. Fascinating, because usually when you follow the money in situations where things don’t make sense, things get curiouser and curiouser.
rolg
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