I continue to search for insights into the Trump administration’s inability to accomplish the removal of Fannie Mae and Freddie Mac from conservatorship—despite Treasury Secretary Mnuchin’s post-election pledge in 2016 to “get them out of government control…reasonably fast”—and the Biden administration’s not appearing even to be trying to do so, despite the companies’ historically high profitability, historically low credit risk, and their centrality to a U.S. mortgage finance system that is struggling to provide adequate financing for low- and moderate-income homebuyers during a period of near-record-low housing affordability.
With this as my intention, on a recent flight from the west to the east coast I listened (on headphones) to an interview of former FHFA Director Mark Calabria by two analysts from Bloomberg Intelligence, on a podcast titled “Calabria on Fannie, Freddie Conservatorships” that had been brought to my attention. I nearly stopped listening when I heard Calabria tell his interviewers that Fannie and Freddie’s “losses from Covid came very close to wiping out all of their capital.” (To the contrary, both were profitable even in the first quarter of 2020, when they put $5.3 billion into their loss reserves to cover Covid-related losses, and they had $52.8 billion in combined profits over the next seven “Covid quarters” of 2020 and 2021, all of which was added to their capital.) But I stuck with the podcast, and afterwards was rewarded when Calabria said something I didn’t recall having heard or read about before: “PIMCO submitted a comment letter during the comment period [for FHFA’s May 2020 proposed capital rule] where they claimed—they never showed their math—but they claimed you would need 12 percent capital to create the equivalent of an explicit guaranty.” Later in the interview Calabria expanded on the topic of asset managers wanting an explicit guaranty or the equivalent on the companies’ debt and mortgage-backed securities (MBS), saying, ‘These asset managers also are large holders of Treasuries, and that is who Treasury hears from every day. And what they’re hearing is, ‘Oh, my God, if you let them out of conservatorship and you don’t give us an explicit government guaranty, everybody will be living in caves again’.”
This latter comment took me back to my days as a financial economist and “Fed watcher”—before I moved over to the business side at Fannie Mae in the mid-1980s—when a fellow economist from the now-defunct firm E. F. Hutton, Ed Yardeni, coined the term “bond market vigilantes,” which he defined as “Investors who watch over policies to determine whether they are good or bad for bond investors,” and whose potential to drive up interest rates by selling bonds in reaction to monetary or fiscal policies they didn’t like imposed significant constraints on policymakers. I knew that large MBS investors like PIMCO and Blackrock had been staunch advocates of an explicit government guaranty for Fannie and Freddie’s securities, but it hadn’t occurred to me that their posture on this issue might be creating a similar “MBS vigilante” reaction at Treasury, giving it another reason for not initiating any action to create a path for Fannie and Freddie out of conservatorship, while instead waiting for Congress to address the phantom issue of “reform” of the companies.
There is, of course, almost no chance that Congress will convey a government guaranty on Fannie and Freddie’s debt and MBS, so if the MBS vigilantes insist on one as a condition of the companies’ release, and Treasury takes them seriously, it would be highly problematic.
In his interview with Bloomberg Intelligence, Calabria greatly overstated the capability of FHFA to remove Fannie and Freddie from conservatorship without Treasury’s concurrence. He said that he and Mnuchin “ended the net worth sweep,” but they did not; they merely suspended it (while increasing Treasury’s liquidation preference dollar-for-dollar) until the companies can accumulate the (excessive) amount of capital Calabria’s “risk-based” capital standard requires of them, at which point it will kick in again. And Calabria’s cavalier claim that, “There is a fair amount the FHFA can do unilaterally…I had my own channels to the White House, and wasn’t dependent on Treasury to get stuff done,” ignores the agreement he signed with Mnuchin on January 14, 2021—five months before his removal as FHFA director after the SCOTUS ruling in the Collins case—that says: “Conservator, by its signature below, agrees that it shall not, without the prior written consent of Purchaser [Treasury], terminate, seek termination of or permit to be terminated the conservatorship of Seller [Fannie or Freddie]…unless, following the Litigation End Date [on which all litigation in excess of a ‘maximum total aggregate potential monetary exposure’ of $5 billion has been resolved], Seller for two or more consecutive calendar quarters has and maintains ‘common equity tier 1 [CET1] capital’…in an amount not less than 3 percent of Seller’s ‘adjusted total assets’.” That language can be changed only if Treasury agrees.
How long might it take the companies to accumulate enough CET1 capital for FHFA to be able to unlock the handcuffs Calabria imposed with this letter agreement, if Treasury does not want to change it? It’s estimatable. At March 31, 2024, Fannie and Freddie’s combined adjusted total assets were $8.335 trillion, making 3 percent CET1 capital $250 billion. Their actual CET1 capital on that date was a negative $110 billion, or $360 billion short of FHFA’s threshold for releasing them from conservatorship. Two years earlier, at March 31, 2022 (the first date the companies began publishing their new regulatory capital requirements), 3 percent in CET1 capital on Fannie and Freddie’s adjusted total assets of $8.139 trillion was $244 billion, while their actual CET1 capital was a negative $162 billion, for a “release shortfall” of $406 billion. At the rate at which the companies have been reducing their CET1 shortfalls over the past two years ($23 billion per year), FHFA would not be able to release them on its own until 2040, and even then, absent Treasury action, the net worth sweep would still only be suspended, not cancelled, and the requirement for the resolution of all material litigation would still need to be met.
This very adverse potential outcome makes it important to closely examine the merits of the arguments PIMCO makes for an explicit MBS guaranty in its comment letter on FHFA’s 2020 capital proposal. That letter is fairly long, and it includes a number of incorrect or exaggerated claims (including that “The GSEs are and always have been non‐economic buyers of mortgage loans”), but its thesis can be summarized in four excerpts that present PIMCO’s version of the history, interpretation, and consequences of the government’s 2008 seizure of Fannie and Freddie.
PIMCO gives the history as: “As you know, when the GSEs were teetering on financial insolvency in 2008, Congress and the Treasury Department took bold action to shore‐up the near insolvent institutions, injecting $191 bn in taxpayer money and placing Fannie and Freddie in conservatorship. At that point, Treasury Secretary Paulson was clear about the government’s intention: ‘Treasury took responsibility for supporting the agency debt securities and the agency MBS . . . effectively, a guarantee on GSE debt and agency MBS’.”
PIMCO’s interpretation is: “Put simply, from a market perspective, the government‐managed conservatorship combined with the extensive taxpayer support provided through the PSPAs, transformed the implicit government guarantee into an explicit guarantee (emphasis in original) in September 2008.” PIMCO then states: “We strongly believe that market participants will not view the release of the GSEs as a return to the implied guarantee model that prevailed before the financial crisis, but rather, they would view them as wholly‐owned private companies with no accompanying government guarantee.” And should this occur, PIMCO avers, the consequences would be dire: “many [investors] would no longer be able to buy, and in some cases, even hold MBS either by law or by their investment guidelines—or at least, they would be unable to do so in the size they can today given single‐credit concentration limits,” with mortgage rates soaring as a result.
Setting aside PIMCO’s repetition of the Financial Establishment’s (false) version of the background of the conservatorships, its doomsday scenario rests entirely on its assertion that the “government’s intention” was to place an explicit guaranty on Fannie and Freddie’s debt and MBS when it took them over. Yet what Paulson said when the conservatorships were announced was actually this: “Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities.…These Preferred Stock Purchase Agreements were made necessary by the ambiguities in the GSE Congressional charters, which have been perceived to indicate government support for agency debt and guaranteed MBS. Our nation has tolerated these ambiguities for too long, and as a result GSE debt and MBS are held by central banks and investors throughout the United States and around the world who believe them to be virtually risk-free.” (Statement by Secretary Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers, September 7, 2008.)
While Paulson clearly expressed dissatisfaction with the implicit guaranty he believed investors inferred from the “ambiguities” in Fannie and Freddie’s Congressional charters, he pointedly did not say that the mechanism he chose to replace that implicit guaranty, the PSPAs, constituted an explicit guaranty. That is PIMCO’s invention, and it is unwarranted.
I understand why Wall Street is lobbying for an explicit guaranty on Fannie and Freddie’s securities; it would raise their value, and make billions for the clients of asset managers. But an explicit guaranty is not just unnecessary, it is a bad idea, because of the precedent it would set. Moreover, there is a much more straightforward way to preserve the companies’ status as government-sponsored enterprises upon releasing them from conservatorship: keep the PSPAs in place, but have Fannie and Freddie pay for them (at a rate “mutually agreed by Purchaser and Seller, subject to their reasonable discretion and in consultation with the Chairman of the Federal Reserve,” per the original PSPA documents). And should investors need reassurance about what this means for the agency status of the companies’ debt and MBS, an affirming word from Treasury would provide it.
In making its case for a guaranty on Fannie and Freddie’s securities, PIMCO also weighed in on another issue that complicates the release of the companies from conservatorship—the amount of capital they are required to hold in order to be deemed adequately capitalized. To be perceived by investors as the equivalent of an explicit guaranty, PIMCO insists, this amount must be extremely high: “Implicit in the FHFA’s proposed capital rule is that the recommended capital framework is sufficient to replace the now‐explicit government guarantee. We fundamentally disagree with this premise and do not believe any reasonable level of capital can replace an explicit government guarantee…Indeed, absent an explicit full‐faith‐and‐credit guarantee of the U.S. government, common equity tier 1 capital should be sufficient to unquestionably cover all GSE MBS guarantee obligations; moreover, our estimate of unquestionably sufficient capital to meet these obligations is more than three times what is recommended under this proposal.”
With that, PIMCO added its name to those putting forth strong recommendations about the correct level of Fannie and Freddie’s capital without making any reference to the credit risk of the only product the companies are allowed to insure—residential mortgages. And the FHFA capital recommendation PIMCO wanted to at least triple (to 12 percent or more) was the 4 percent minimum proposed by Calabria, which was arbitrary as well. Here is how Calabria defended this figure in his interview with Bloomberg Intelligence: “If you’re trying to create an objective where you’re having a foundation where the companies can survive a stress period then, you know, to me, 4 percent is on the low end.” He was increasing the companies’ minimum capital from the 2 ½ percent that had been in effect since 2018, and his comment on that in the interview was equally speculative: “If we had gone with the two and a half—which is what some people wanted—I mean you’re almost certain that the shareholders will get wiped out in the future, because there’s just no way the companies would survive over a long period of time with just 2 ½ percent equity.”
PIMCO’s wild capital recommendation was excusable, but it was surprising, and very disappointing, to hear Calabria talk about Fannie and Freddie’s risk and capital as if their annual Dodd-Frank stress tests either did not exist or were of no significance. And neither his comments to Bloomberg Intelligence nor the PIMCO letter revealed any awareness of the fact that mortgage credit risk is one of the few financial risks that can be reasonably well quantified and modeled in a stress test, because of the massive amount of data that exists on it. Nor was there any acknowledgement from either party of the importance of striking a balance between having enough capital to protect taxpayers (and debt and MBS holders) while not requiring so much that Fannie and Freddie’s ability to carry out their chartered missions is unnecessarily impaired.
There is a Congressional requirement for Fannie and Freddie’s risk to be measured with a stress test, but it has been distorted. Calabria simply was not being truthful (perhaps with himself) when he said in the Bloomberg Intelligence interview, “The second I took the oath [as FHFA director] my views or preferences went out the window…. I wasn’t pursuing my own agenda; I was pursuing the agenda that Congress placed upon me” …which was that “the risk-based capital standard should make sure that the companies had a positive going-concern value during a stress environment.” As I’ve noted in several prior posts, Calabria brought with him to FHFA the notion that Fannie and Freddie should be subject to the same 4 percent capital minimum as had been required of banks’ residential mortgage holdings (on which they take short-funded interest rate risk, and which have a historical credit loss rate triple that of Fannie and Freddie), and then, while professing to be complying with the Congressional mandate to implement a risk-based capital standard, he cynically employed enough conservative assumptions, cushions, buffers and add-ons to make its results come out even higher than his pre-determined 4 percent minimum capital amount.
The insistence of the MBS vigilantes on an explicit government guaranty for Fannie and Freddie’s securities, a net worth sweep that has left the companies with a negative $110 billion in CET1 capital even after twelve years of consistent and now record profitability, and a March 31, 2024 “Calabria capital requirement” averaging 4.28 percent of total assets for two entities that for the past two years have required no initial capital to withstand a repeat of the 2008 financial crisis as imposed upon them by the Dodd-Frank stress tests all share a common attribute: they are based on falsehoods, not facts. To exit conservatorship, Fannie and Freddie do not need to be “reformed” by Congress; they need Treasury and FHFA to not base their policy determinations on things like PIMCO’s attempts to achieve a windfall for its investors, fictions about the origins and legitimacy of the net worth sweep, or the personal preference of former Director Calabria as to what the companies’ required level of capital ought to be. There are actual, unassailable and readily accessible facts that address each of these issues. It is shameful that no administration has yet had the wisdom, will or courage to use those facts to end the nearly sixteen-year conservatorships of two companies who, if allowed to operate their business as privately-managed entities on an economic basis, could meaningfully lower the cost of mortgage finance for millions of low- moderate- and middle-income Americans, at a time when they sorely need it.
HOWARD ON MORTGAGE FINANCE 
Tim
Here is a link to my most recent substack post, which your readers may find interesting: https://open.substack.com/pub/ruleoflawguy/p/glimpsing-the-gse-restructuring?r=dhcl9&utm_campaign=post&utm_medium=web&showWelcomeOnShare=true
ROLG
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IF the government’s goal is to monetize the value of its investment in the companies (in the form of the senior preferred and the warrants), then I agree with most of what you say in this piece–although I would add that to get the maximum value out of its ownership stakes in Fannie and Freddie the administration also should make them more valuable by having FHFA replace the ideology-based Calabria capital standard with one based on economics. But there are other potential objectives for Fannie and Freddie as well–ranging from the “full privatization” of Project 2025 at one extreme to embracing the companies’ potential to meaningfully increase the availability and reduce the cost of mortgage finance for low- and moderate-income borrowers at the other. We should get some clue as to the new administration’s true objectives once the President-elect reveals his choice for Treasury Secretary, which seems to have been stalled by behind-the-scenes divergences of viewpoints.
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Tim
Thanks for the reply. What was not discussed in my post is the interplay between a paid-for capital line of credit from Treasury (which I expect to be a part of the restructuring) and whether the ECRF will be revised (and capital buffers reduced or eliminated) by the new FHFA director (a one year notice and comment process which might attract adverse political attention). I did address the ECRF in a prior post as being unrealistically stringent. I suspect that capital adequacy fright will be a hurdle for political acceptance of any administrative GSE restructuring, but given the Trump cabinet nominees to date, I also suspect that political attention on GSE matters may be diverted elsewhere to a great extent in this second term.
ROLG
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Tim
I wrote above that if the new FHFA director wanted to nuke the ERCF it would take a lengthy notice and comment period under the APA to materially changer replace it. I think this is right as a matter of conventional thinking. if it is right, then any recap/release scenario would have to proceed either with the ERCF in place, or under uncertainty if and when anything would replace it.
I set forth below a quote from a recent WSJ op-ed by DOGErs Musk/Ramaswamey about a more unconventional manner of proceeding to change agency regulations:
“DOGE will work with legal experts embedded in government agencies, aided by advanced technology, to apply these rulings [two SCOTUS cases re major questions doctrine/no more chevron deference] to federal regulations enacted by such agencies. DOGE will present this list of regulations to President Trump, who can, by executive action, immediately pause the enforcement of those regulations and initiate the process for review and rescission. This would liberate individuals and businesses from illicit regulations never passed by Congress and stimulate the U.S. economy.”
So under this theory, the new FHFA director working with DOGE could propose to POTUS that the ERCF be rescinded. The argument would be that the ERCF derives no substantive support from Congress or HERA for its excessive conservatism. The recap/release process could then proceed under the HERA statutory standard (essentially 2.5% of assets) with a new regulatory framework approved when it is approved.
ROLG
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https://www.semafor.com/article/11/19/2024/trump-readies-short-list-for-financial-agencies
“Jonathan McKernan, one of two current Republicans on the FDIC board, may be tapped for the Federal Housing Finance Agency”
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This response when McKernan was at the FDIC, and particularly footnote 16, might help elucidate his thinking on the GSEs:
https://fdic.gov/news/speeches/2023/spjul2723c.html
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In this statement, McKernan argues against accepting the higher capital requirements on bank residential mortgage holdings proposed in Basel III. If he IS appointed as the next director of FHFA, I hope he stays with the principles and the reasoning he advances in this paper, specifically, “Basing an exposure’s risk-based-capital requirement on that exposure’s risk should be, as the term suggests, the key principle for calibrating that requirement”….and, “There likely will be real economic costs [of the ‘significant increase in capital’ for bank mortgage holdings in Basel III]. Large banks generally would see an increase in the capital requirement on mortgage loans to borrowers who cannot afford a 20% down payment. The increased capital requirements could lead to an increase in interest rates for low- and moderate-income and other historically underserved borrowers who cannot always afford a 20% down payment, making it that much harder for these families to achieve homeownership.”
As I will document in a post I plan to do in the coming weeks, “low- and moderate-income and other historically underserved borrowers” are in fact being charged extremely and unnecessarily high fees to guarantee their mortgages because of the Calabria capital standard that applies to Fannie and Freddie, precisely because it (deliberately) is NOT risk-based.
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@ROLG – Excellent piece on Substack. I’m also deeply uncertain of how the process will unfold. In my view, the first signal will be whether FHFA decides to revisit the capital requirements. I would assume the first signs of this process would emerge sometime in 2025 if they go down this road (or it will be too late to finish it and finalize SPS & JPS restructuring terms).
One scenario I’ve been wondering about is whether Treasury could deem the SPS “payable” and in effect turn the NWS back on – but in such a way that the SPS balance gets paid down over time. They can commit to holding their common shares (after warrant conversion) until this is finalized. This would (with a revised capital rule) allow conservatorship to end, funnel payments to Treasury to the tune of $15-20 billion/year, avoid “bailing out evil hedge funds” via SPS cancellation or bringing GSE liabilities onto the federal balance sheet (via SPS conversion and 100% equity ownership). The downside is that it would take 10+ more years to pay down the SPS a second time. But by this point, I’m not sure the government really cares.
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I will leave this comment up (at least for a while), but would like to request that future comments on ROLG’s substack pieces be made on his site, rather than here.
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http://www.youtube.com/watch?app=desktop&v=RQmUzx13UEE&list=PL_QkMqEzOkzNmWUe9kpfRJ4213jIh6LNk&index=1
“Our mortgage system may not be perfect, but best of the world.”
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Tim
another newsletter post of mine: https://open.substack.com/pub/ruleoflawguy/p/the-fhfa-director-gse-capital-and?r=dhcl9&utm_campaign=post&utm_medium=web&showWelcomeOnShare=true
ROLG
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I think this piece is excellent, and I commend it to readers.
And for those who do want to “get into the weeds of the Calabria ERCF” as to why it is so indefensible and so damaging to the ability of Fannie and Freddie to provide affordable housing support to the low- and moderate-income borrowers they were chartered to serve, I recommend re-reading my 2021 post “Capital Fact and Fiction,” accessible on this site under the “Top Posts” tab.
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Tim
Thanks for your commendation.
I once had a college professor who said you should always go back to your roommate who is not taking the course and explain to him (in my situation) what you learned, what the issues were etc, and see if he could mirror back to you what you said in an intelligible fashion.
This piece was that, in essence GSE Capital For Dummies, though I decided to pass on that title.
ROLG
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Tim, While I know that you stay away from speculating , what are your thoughts on the possibility of the current admin hastily attempting to resolve the Conservatorship Saga in the last 60 days, given that the way the Dems want to resolve the housing saga (Affordable housing) vs how the Republicans want to solve it (Privatisation), and the fact that for the next 2 years every part of the government will be in the Republican hands; do you see any hasty attempts in the works?
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I think it is highly unlikely that we will see any last-minute activity on the part of the Biden administration to address the conservatorships of Fannie and Freddie, primarily because neither of the principals who would have to make critical decisions in such an initiative–Treasury Secretary Yellen (on ending the net worth sweep and eliminating Treasury’s senior preferred stock and its liquidation preference) or Sandra Thompson (on reconciling the glaring inconsistency between the last few years’ results of the companies’ Dodd-Frank stress tests and their 4-plus percent required “risk-based” capital)–have given any public indication that they ever have been focused on it. And even were they to suddenly be, there isn’t enough time remaining for them to get anything of significance done.
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Tim
I have restarted my newsletter with the event of Trump’s POTUS victory: https://ruleoflawguy.substack.com/p/oh-to-be-unburdened-by-what-has-been
I hope that it will be of interest to your readers.
ROLG
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I already got your first post! I think our next questions are “Who will Trump pick for Treasury Secretary?” and “Who will Trump pick as director of FHFA?” If Paulson is picked for Treasury and we get someone like Mike Calhoun for FHFA, I feel like this could be quick. If Zandi gets in there, I feel like this could be a mess, but he seems to have transitioned his stance in recent times so I could be wrong. Some things to watch!
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Juice
it is my understanding that the transition team has done work on identifying the FHFA director, and are ready to move quickly. If it is who I think it is we will all be pleased.
Who the Treasury secretary is will be crucial for a GSE restructuring, and the names I have seen floated all have a financial or investor background, with no particular ties to Tim’s Financial Establishment or academia (which is a plus). So we shall see.
Apart from the cabinet members involved, there are many reasons to be more optimistic this go around than last, not least of which is that the GSEs have accumulated substantial net worth in the past four years, making a conservatorship release more feasible, though there is much work still to be done.
ROLG
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Why not Tim Howard for FHFA?
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Has anyone read the new article co-authored by Alex Pollock?
https://thehill.com/opinion/finance/4972622-fed-mortgage-backed-securities-losses/
Strongly suspect the value of MBS automatically go down as the mortgages backing them are amortized over the term of the mortgages. In the meantime the Fed has been collecting interest on these MBS. I considered responding to them and Richard Whalen who shared the article on X, but would rather hear from those more qualified first.
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I had not read the article, but after doing so I have to point out that there is a very important prelude to what Pollock is reporting here (which I’ve discussed a few times in previous blog comments) that he conveniently omits.
Prior to the Financial Crisis, Pollock joined Fed Chairman Greenspan in falsely asserting that Fannie Mae’s mortgage portfolio business (which nearly hit $1 trillion in size when I was responsible for managing it) posed unacceptably high risk to the U.S. financial system (ignoring the facts that it was closely duration matched and continually rebalanced). When Fannie and Freddie were put in conservatorship, one of the elements of the Senior Preferred Stock Purchase Agreement was a mandate that the companies shrink their portfolios by 10 percent per year (later increased to 15 percent per year), even though these portfolios were very profitable at the time, and generating income that was offsetting losses from the companies’ credit guaranty businesses.
At almost exactly the same time, the Fed began to purchase Fannie, Freddie and Ginnie Mae MBS, knowing that shrinking Fannie and Freddie’s portfolios would put (unwanted) upward pressure on mortgage rates. But when the Fed buys MBS (or any asset), it does so by crediting the reserve accounts of the banks used by the sellers of those MBS, and those reserves pay interest. As long as that rate was 15 basis points–as it was through the spring of 2022–this worked fine. But then it rose, hitting 5.40 percent in the summer of 2023, which was much higher than the average note rates of the MBS it has purchased. That rate has since fallen to 4.90 percent, but it’s still well above the average note rate on the Fed’s MBS portfolio. When I last wrote about this I calculated the losses the Fed’s portfolio was throwing off, and as I recall it was well over $100 billion a year. I haven’t updated that, but I suspect the numbers Pollock is now exclaiming about may be correct.
But here’s the point, that Pollock omits. The Fed–which along with many others criticized Fannie and Freddie’s matched-duration portfolio businesses, resulting in Treasury requiring them to be wound down–took up the slack by short-funding its own portfolio of 30-year fixed-rate mortgages, purchased at historically low interest rates, that totaled over $2.7 trillion at its peak in 2022 (and still is $2.27 trillion), and the financial media are utterly silent on the massive losses that have been incurred as a result of this blunder. And yet even though Fannie and Freddie are no longer in the portfolio business–and their credit guaranty business requires zero initial capital to withstand a repeat of the 2007-2011 meltdown in home prices–they remain chained in conservatorship because the same people in the Financial Establishment, including Pollard, who cried wolf about their portfolio business now are doing the same thing about their credit guarantees, and requiring them to be grossly overcapitalized, at the same time as the Fed continues to hemorrhage real losses on its MBS portfolio unremarked.
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https://x.com/Ny1david/status/1846606816504942598?t=KNp53lutmnr7jZfMLYIhYg&s=19
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David sent me a link to this earlier today, and I think he makes good points.
I also had a request yesterday to approve a comment linking the Cato Institute article by Norbert Michel, and asking for my comments on it. I didn’t approve the post, because I don’t want my blog to be a vehicle for spreading the nonsense Michel writes, nor do I want to take the time to rebut it (rebutting deliberately uninformed articles about Fannie and Freddie is like running on a hamster wheel–it’s endless and exhausting).
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Thank you, Tim. This type of academic analysis is the CATO Institutes bread and butter – theoretically strong academic libertarian ideals with a complete absence of functional reality. It is not obvious if Michel deliberately avoids how the private market actually operated or if he is unaware of its massive fraud and failure that destroyed the housing market and financial system – either road is a triple-lane superhighway that discredits his piece. Viewing Michel’s bio supports the academic blind eye to real-world operation.
Finally, nothing in this piece is new and it could have been published at any time during Biden’s administration; therefore, I view the timing and content as an attempt to prime those who may become involved with or in a position to influence a potential incoming Trump administration.
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Tim,
Could you post about what you think is going to happen when the government’s warrants for 79.9 percent of Fannie and Freddie’s common stock expire in 2028?
And if you have already done that, please share the link.
ZC
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I addressed this issue in late July, in response to a question, here: https://howardonmortgagefinance.com/2024/07/09/the-mbs-vigilantes/#comment-30597.
And I added this comment in response to a follow-up question: https://howardonmortgagefinance.com/2024/07/09/the-mbs-vigilantes/#comment-30603.
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See what I believe to be a paywall-disabled link to today’s WSJ article regarding Trump’s plans to “privatize” Fannie/Freddie if elected POTUS: https://www.wsj.com/politics/policy/trump-allies-are-working-on-plans-to-privatize-fannie-and-freddie-a9c4e5ff?st=qNZp9Q&reflink=desktopwebshare_permalink
ROLG
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ROLG–Thanks for posting this; it’s good to see an article on Fannie and Freddie that cites actual sources.
Having said that, though, as the article says it’s not a “Trump plan” (“‘The [former] president himself has never said anything about this throughout the campaign,’ a Trump campaign spokeswoman said”); it’s something being discussed by a group of Trump supporters (of whom only Larry Kudlow and John McEntee are named). And I wouldn’t even call it a plan–it’s more a statement of aspiration.
Early on the article states, “The government’s stakes in Fannie and Freddie could be valued at hundreds of billions of dollars, bankers estimate. That could allow the government to sell more than $100 billion of securities in one swoop, some bankers say.” The key word in both sentences is “could.” As of yesterday’s close, the market value of Fannie and Freddie combined (fully diluted shares of outstanding common stock times closing stock price for each) was not “hundreds of billions of dollars;” it was $9.94 billion. Treasury’s current share of that (based on exercise of its warrants for 79.9 percent of the companies’ fully diluted shares of outstanding common) is $7.94 billion. An actual “plan” for releasing Fannie and Freddie would describe and detail the specific actions that would move the value of “the government’s stakes” in the companies from $8 billion to “hundreds of billions.” On several occasions I’ve given MY plan for how to do that–cancel the net worth sweep, deem the Treasury senior preferred stock to have been repaid (as it has been) and eliminate Treasury’s liquidation preference, and replace the excessive and arbitrary “Calabria capital requirement” with a true risk-based requirement that allows Fannie and Freddie to price their credit guarantees on an economic basis. If Kudlow, McEntee et al have a different plan in mind, they haven’t told the Wall Street Journal (or have done so “off the record”). And without details, it’s just words.
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my takeaway from this news plant is that at least Trump et al would be going in with having worked on a plan as opposed to last time in office, when the Trump administration diddled and muddled around the issue with no one competent in charge.
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much discussion about D plan to build 3MM more housing units, beginning with the “emerging YIMBY movement” (see paywall disabled https://www.wsj.com/politics/elections/pro-housing-yimbys-for-kamala-harris-cf3cb3b8?st=EZzPre&reflink=desktopwebshare_permalink)
All well and good though this will cost money, and it would be hard to find sufficient change in the couch cushions to do this without congressional appropriation, a constitutional requirement one presumes is still the law of the law, and this might not be forthcoming with a split R/D congress.
One would think Zandi/Parrott would chime in at this point with a funding mechanism built on the cash flow from monetizing Treasury’s GSE warrants. If you are in email communicato with Zandi, I would be interested in his thoughts on this (or if this lays outside of a more narrow remit of his).
In any event, this Tuesday is Constitution Day, not that you will find it noted as such on any online calendar, and I hope all of us may honor this very important part of our civic inheritance appropriately.
ROLG
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ROLG–As I’ve noted before (but not in a while), I don’t discuss or mention the content of any contemporaneous contacts I have with people who are active in the policy dialogue affecting Fannie or Freddie, because I believe I can be more effective if these are done on a confidential basis and behind the scenes. (I don’t view my giving a brief summary of the correspondence I had with Zandi on CRTs eight years ago, as I did below, to be a violation of that principle….)
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There’s a new site created by Robert Kennedy Jr for the public to recommend policy changes. Attached is my recommendation.
https://forum.policiesforpeople.com/t/release-fannie-mae-and-freddie-mac/1726
On the upper left is a blue box to vote for the recommendation as a sign of support. You and your readers can also add comments.
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As regular readers of this site know, I don’t “Tweet” (or, now, post on ‘X’), nor do I comment on other internet sites; anything I have to say I do in a post, or as a response to a comment or a question, on this site.
When I began Howard on Mortgage Finance in early 2016, I did not expect it to be going nearly nine years later. But it is, because with the conservatorships of Fannie and Freddie still unresolved, I believe there continues to be a need for fact-based information and analysis about the companies. Over the years, however, my new posts have become less frequent. During the first three years I averaged about one post a month, since there was a lot of information about the companies that was not generally known and I thought needed to get out. Over the next three-year period I did a post about every two months, and since then my frequency of new posts is down to about one every four months. I don’t like to repeat myself, but do maintain a section in the blog labeled “Top Posts,” which readers can consult to refresh themselves on the main observations and prescriptions I’ve made about Fannie and Freddie in the past. And I very likely will put up a new post sometime between election day and mid-December, targeted at the “thought leaders” of whichever political party prevails in the presidential election, that will contain my views as to what they should do with Fannie and Freddie going forward, and why.
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I recently saw in a Twitter post that the Harris campaign is against releasing the GSEs from conservatorship based on a 2015 paper by Parrott and Zandi that finds mortgage costs would go up if the entities are released.
Are you familiar with this paper? Seems like a lot has changed since 2015. Do you believe the paper is relevant today?
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I had to look up the 2015 Parrot and Zandi paper, to refresh myself about it. It’s from The Urban Institute, and is titled “Privatizing Fannie and Freddie: Be Careful What You Ask For.” To answer your question, it definitely is not relevant today.
Back in 2015, virtually everyone was on board with the idea—put out by the large banks—that Fannie and Freddie had to be replaced for the U.S. mortgage finance system to function effectively again. Parrot and Zandi’s 2015 paper began with this: “[L]egislative efforts to replace the system have largely faltered, raising concern that we may not have the political will or competence to replace it any time soon. This has created an opening for those who contend that we should not replace the system at all, but simply recapitalize the government-sponsored enterprises and release them from conservatorship.” Parrot and Zandi then unleashed a “parade of horribles” they claimed would ensue if recap and release were attempted, including a 10 percent capital requirement because the Financial Stability Oversight Council would designate them as Systemically Important Financial Institutions (SIFIs), and an extremely high annual commitment fee to keep the Senior Preferred Stock Purchase Agreements in place—both of which would drive their guaranty fees to astronomically high levels.
The motive for this Parrot-Zandi paper became clear the following year, when in March of 2016 they and three other authors released the Urban Institute paper, “A More Promising Road to GSE Reform,” that advocated combining Fannie and Freddie into a government entity called the National Mortgage Reinsurance Corporation, which would back the MBS it issued with credit risk transfer (CRT) securities that would serve as its primary source of capital, with a secondary capital level consisting of junior preferred stock. I still have a copy of the 26 pages of emails I exchanged with Zandi arguing that it would be folly to replace hard equity capital with contingent CRTs (which lose money for the companies), and that he and his colleagues HAD to come up with a valid measure of equity equivalency before counting CRTs as capital. Zandi agreed with the validity of the equity equivalency metric, and said they were working on one. They never produced anything, and the “Promising Road” died, as did other proposals (such as Johnson-Crapo) to replace Fannie and Freddie.
Today, of course, the consensus of the Financial Establishment on Fannie and Freddie has changed from replacing them to releasing them, but with “conditions.” Those conditions are intended to keep the companies’ guaranty fees high to increase the profitability of primary market originators and portfolio investors, but are publicly justified as necessary because of Fannie and Freddie’s “risks”—which are grossly exaggerated. I don’t know where Zandi and Parrot are on the risk issue. Will they really support Calabria’s 4 percent capital level for the companies, despite their having survived their last two Dodd-Frank stress tests with zero initial capital (and FHFA’s giving itself a waiver to delay publishing the results of this year’s stress test “so that the Enterprises may provide additional supporting information and analysis of the scenarios”)? I would hope not, because there is no analytic basis for doing so, but we’ll have to see.
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“I would hope not, because there is no analytic basis for doing so, but we’ll have to see.”
Or not see
ROLG
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On Sep 10th (the same day of the Trump v. Harris debate), Michael Barr (Federal Reserve Board Vice Chair for Supervision) gave a speech at Brookings. In it, he mentioned adjustments to Basel III “endgame” capital requirements. One of the adjustments will be reduced capital required for mortgage loans from today’s levels, to bring it more in line with actual risk. If bank capital requirements for mortgages decrease to better reflect risk, wouldn’t the FHFA also want to do the same? I’m wondering if this may be the “behind the scenes” push that could finally result in a more sensible capital rule. The link to the speech is below, and it is only a very brief mention about mortgages. Would be interested in your thoughts. Speech by Vice Chair for Supervision Barr on Basel III endgame – Federal Reserve Board
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Any time facts creep into the discussion about what to do about Fannie and Freddie, it’s a good thing. What’s significant about Barr’s reference to mortgage credit risk in the comments he made about Basel III at Brookings is that it highlights the critical difference between the capital standards for the banking industry and for Fannie and Freddie: the former are unquantifiable– because banks engage in so many different types of activities, and there are many different types of banks in many different countries–whereas Fannie and Freddie are the only two (federally chartered) companies that are limited to dealing in just one asset type in one country and one currency, and the risk of that asset type (residential mortgages) IS quantifiable. Barr cites the “actual [credit] risk” of mortgage loans as a justification for reducing overall bank capital standards, and that of course SHOULD raise the question, “well, if we use actual mortgage risk as an input to where to set overall bank capital requirements, shouldn’t actual mortgage risk also be used as the basis for setting Fannie and Freddie’s total capital requirement (since that’s their only business)?”
As I discuss in my current post, former FHFA director Calabria deliberately ignored actual credit risk in promulgating his Enterprise Regulatory Capital Framework (ERCF) for Fannie and Freddie in 2020–he imposed a “bank-like” 4 percent minimum capital requirement on the companies (despite the fact that they literally have NO business in common with commercial banks), then used enough conservative assumptions, minimums, buffers and add-ons to make the results of their Congressionally-mandated risk-based standard come out higher than his arbitrary minimum. The result of this was that as of March 31, 2024, Fannie and Freddie had an average “Calabria capital requirement” of 4.28 percent of total assets, even as the results of their last two published Dodd-Frank stress tests showed they needed NO initial capital to survive a stylized repeat of the home price collapse that occurred during and after the Great Financial Crisis.
And that ties to another fact that may be percolating “behind the scenes.” I am surprised that no financial media have asked current director Thompson why FHFA gave itself a waiver from publishing the results of the companies’ 2024 Dodd-Frank stress test before its statutory August 15 deadline (FHFA said it was “so that the Enterprises may provide additional supporting information and analysis of the scenarios”). FHFA asked for a similar waiver once before–in 2020, when the August 15 deadline fell before the end of the comment period on Calabria’s proposed ERCF. Calabria asked for that waiver because he claimed “that achievement of the purposes of the Safety and Soundness Act will be adversely affected if each Enterprise’s publication of the summary of its Dodd-Frank Act stress test results is not delayed so that each Enterprise may include the alternative scenarios considered by the Board.” No alternative scenarios ever were released, and the base 2020 stress tests weren’t released until August of 2021 (along with the 2021 stress test results). It seems inescapable that Calabria delayed publication of the 2020 Dodd-Frank test because he didn’t want potential commenters on his ERCF noting the contrast between the results of that test (zero required stress capital) and his made-up statutory “risk-based” requirement of over 4 percent. What, then, might be behind Thompson’s decision not to publish the results of the 2024 test (which almost certainly again will show zero initial capital required to pass it) on time? Might FHFA be beginning to be defensive about the sharp, and inexplicable, contrast between the continued message sent by the Dodd-Frank tests–Fannie and Freddie are ready to be released from conservatorship now–and the sentence of fifteen additional years of captivity imposed on them by the indefensible Calabria capital requirement?
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Awhile back I inquired about the impact of the GSE warrant expiry dates on GSE policy going forward.
As the expiry date falls within the window of the next administration, I posited that it would impact political actors to do something, good or bad, on GSE policy in the coming term. Some readers (e.g. Rule of Law Guy) claimed the deadline could be bypassed somehow. You indicated that it is a real deadline but is too far into the future and that something would occur before then making the point moot (although I don’t want to falsely state what you said – so feel free to correct me).
If this is a real deadline, why do the political parties not acknowledge the existence of the warrant expiry dates? Why do no media reports mention or inquire about this reality and why wouldn’t FNMA/FMCC management be explaining how this will impact their mission and future decision making in the coming 4 years in their statements or in their commentary with congress?
Unless I am missing an abundance of commentary that is actually out there!
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The term sheet granting Treasury warrants to purchase “79.9% of the total number of shares of [Fannie Mae or Freddie Mac] Common Stock outstanding on a Fully Diluted basis on the date of exercise…at a price of one one-thousandth of a cent per share,” explicitly states that these warrants will expire at 5:00 pm New York time on September 7, 2028. It is in that sense that this is a “real deadline.” Before that time, Treasury must either exercise the warrants or agree with FHFA to extend them to some future date, or else they will expire. I don’t know which of these three options (exercise, extension or expiration) a future Treasury Secretary will elect, and I have no basis for speculating on it.
The lack of commentary about the expiration date of the warrants is not surprising to me, because the statement that what is done with them “will impact [Fannie and Freddie’s] mission and future decision making in the coming 4 years” is not correct. The exercise or non-exercise of the warrants will have no direct impact on any aspect of the companies’ business; it only will affect the price their common stock. And even here the impact is difficult to quantify. On a fully-diluted basis (i.e., assuming conversion of the warrants) Fannie and Freddie’s weighted-average $1.31 closing stock price yesterday gave them a market capitalization of only $12 billion, less than half their sustainable annual earnings of $25 billion per year. It is not just the warrants that are holding down the price of the companies’ common stock; it is all of the other uncertainties associated with their conservatorships–the fate of the net worth sweep, what Treasury will do with its senior preferred stock and liquidation preference, and whether and how the companies’ capital requirements will be changed (to allow them to price their business on an economic basis). All these will need to be resolved before it will be possible to put a fair value on Fannie or Freddie common stock–whether the warrants are converted or not.
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With so much speculation currently focused on what potential Presidential administrations might do to the GSEs (both in the short term and at the Sep 7, 2028 ‘deadline’), I wonder if you might share your perspective on GSE earnings–and possibly what they portend for future earnings.
According to Inside Mortgage Finance (IMF), Fannie Mae, in the face of headwinds from high interest rates and supply shortages, maintained profitability in Q2, with net income of $4.5B (up $164M from Q1 and down $510M from Q2 2023) and year-to-date net income of $8.8B steady compared with the first six months of 2023. Fannie’s Q2 net interest income was $7.3B, up from $7.0B in both Q1 2024 and Q2 2023.
IMF raised concern—arguing that “Fannie’s earnings have clearly plateaued”—re: shrinking earnings despite an increase in volume:
“On the single-family side, conventional acquisitions totaled $85.9 billion for the quarter, up from just $62.3 billion the prior period. Most of that 37% increase came from purchase-mortgage acquisitions, but refinances were also up 22%.
One telltale: Fannie’s average single-family guarantee fee ended its three-quarter rise, dropping from 54.9 basis points in the first quarter to 51.9 bps in the second. Meanwhile, its single-family book of business also fell, as paydowns, liquidations and sales outpaced acquisitions in the quarter.”
Do you share any of IMF’s concern over ‘plateauing’ earnings given increased volume? And what do you make of the Q2 3bp drop in the guarantee fee?
Thanks again for your clearheaded and informed writing and advocacy on all things GSEs.
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I did not see the IMF piece on Fannie Mae’s second quarter 2024 earnings, but if it claimed that Fannie had “shrinking earnings despite an increase in volume,” that’s incorrect, or at best misleading. The conventional loan acquisition numbers IMF cites as being “up 37%” are for the second versus the first quarter of this year, and over those two quarters, Fannie’s earnings did not “shrink,” they rose modestly. More importantly, the sharp rise in loan acquisitions from the first to the second quarters this year was almost entirely a seasonal phenomenon (Fannie’s conventional loan acquisitions rose 32% between the first and second quarters of 2023), and because it was matched by a similar (seasonal) jump in mortgage liquidations it had no measurable effect on either the size of the company’s single-family book of business–which actually shrunk during the quarter–or its net interest income.
It’s also too simplistic to say that Fannie’s earnings have “clearly plateaued.” So far in 2024 Fannie’s earnings are running at an annual rate of $17.6 billion. Its earnings over the past five years have averaged $15.7 billion per year, but because of temporary factors they’ve ranged from as low as $11.8 billion in 2020 to as high as $22.2 billion in 2021. There’s no obvious plateau in these numbers.
In order to make a reliable forecast of Fannie’s future earnings, you have to focus on the key drivers of those earnings. In the past there have been three: the size and growth of the book of credit guarantees, changes in the average guaranty fee rate, and the size of the benefit or provision for credit losses. But in the last couple of years, a fourth key driver has emerged–the fact that the company’s total stockholders’ equity can be invested at market interest rates. Taking each one (briefly) in turn:
Fannie’s single-family book of credit guarantees is smaller today than it was at June 30, 2023, and even adding its multifamily book Fannie’s total guaranty book still was smaller at June 30, 2024 than a year earlier, despite the fact that single-family home prices have risen by close to 7 percent over the past twelve months. As I’ve said previously, this almost certainly is the result of non-competitive guaranty fee pricing, caused by excessively high capital requirements. I would be surprised if we see much if any growth in Fannie’s credit guaranty book until this overcapitalization issue is addressed.
In the second quarter of 2024, Fannie’s charged fee on new single-family business was 51.9 basis points, down from 54.8 basis points in the first quarter. Fannie said this was “primarily as a result of a shift in product mix and an improvement in credit profile.” Reading between the lines, I think Fannie is having difficulty financing riskier business because the guaranty fees it has to charge on that business are too high for borrowers to afford. For that reason, I would not expect Fannie’s fees on new business to average much above 50 basis points in the foreseeable future, and if that is the case, the company’s average guaranty fee rate of 47.6 basis points on its total book should drift slowly toward that average rate on new business, giving a modest push–but only that–to net interest income.
These first two factors–a flat to possibly declining book and a very slowly growing average fee rate–argue for only very modest growth in net interest income. And our third key driver of Fannie’s net income–the loss provision–almost certainly will be a negative. The unexpectedly rapid home price appreciation since Fannie was required to adopt current expected credit loss accounting has resulted in the company taking benefits for credit losses (which add to net income) rather than making provisions for future losses, to the point that its loss reserves have been reduced to extremely low levels–at June 30, 2024 just 15 basis points on its $3.85 trillion single-family book and 48 basis points on its $482 billion multifamily book. That simply can’t continue, and it won’t. At some point soon Fannie will again begin making normal provisions for credit losses, and when it does this will be a drag on earnings.
But…there now is very positive factor adding to earnings: Fannie’s ability to keep its retained earnings (and not have to turn them over to Treasury in a net worth sweep), and the fact that those retained earnings are invested in short-term securities. At the end of the first quarter of 2022, Fannie’s $51.7 billion in shareholders’ equity was invested in short-term securities paying 15 basis points, earning $77 million per year. At June 30, 2024, however, Fannie’s $86.5 billion of shareholders’ equity was invested in short-term securities at 5.3 percent. That’s $4.6 billion in pre-tax net interest income ($3.0 billion after tax), and with no change in interest rates these earnings will grow at the same rate as Fannie’s retained earnings. For that reason, the company’s net income probably will trend modestly higher over the next couple of years, even with higher loss provisions and the continued growth in non-economic credit risk transfer costs.
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Thanks for your considered response.
I’m wondering about your thoughts on an infographic shared by Fannie CEO Pricilla Almodovar on LinkedIn Aug 13. She prefaced the graphic by writing, “Fannie Mae continues to reduce its capital shortfall as disclosed in our recent Enterprise Regulatory Capital Framework disclosures. These charts help explain why:”
I’m interested to hear what you think about the accuracy of that information to her stated goal of explaining why Fannie has recently reduced its capital shortfall. What other pieces of information would you use to supplement that picture, if you were interested in making the case she does?
I also wonder what you think of her making the case she does. What do you think her intended audience is and what do you expect that information was intended to do? Do you think it’ll have the desired effect?
Finally, do you think there’s a way for Almodovar (or others at Fannie & Freddie) to discuss either the causes of the GSE’s capital shortfalls or potential remedies?
Also, another Almovodar post from a month ago lists WaPo’s naming Fannie as the #1 place to work in D.C. She argues this “is a testament to Fannie Mae’s culture…”. Obviously, this is a post every CEO in the world would make. What do you think of Fannie’s culture and its ability to hire and retain the talent it needs to be and remain competitive? If the company is doing fine now, do you think there’s a point in which current policies and restrictions will impinge on its abilities to attract and keep the people it needs to function optimally?
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I haven’t seen the infographic Ms. Almodovar put up on LinkedIn, but all of the data on Fannie Mae that she gives in the four points in your comment are correct. Since the focus of her piece is on the elements of Fannie’s risk and capital that IT controls, I wouldn’t add anything to this. Almodovar was, however, silent (I think deliberately) on the elements of the company’s capital shortfall that it does NOT control–namely the net worth sweep and the $121 billion in Treasury senior preferred still on the balance sheet that does not count as regulatory capital (and are what cause the company’s regulatory capital at June 30, 2024 to be a negative $45 billion), or the preposterous $48 billion “stability capital buffer” and $34 billion “stress capital buffer” that make its total capital requirement at the end of last quarter not $102 billion but $184 billion (a figure Almodovar does not cite), and make its regulatory capital shortfall at June 30, 2024 $229 billion (a figure she also does not cite).
I interpret the message of Almodovar’s piece as being, “Fannie has done everything it can to position itself to exit conservatorship; the rest is up to others.” Those (unstated) others, of course, are FHFA and Treasury. As to the “causes of the GSEs’ capital shortfalls [and] potential remedies,” almost anyone who has been paying attention to the plight of Fannie and Freddie knows what they are, although no one, including in the media, seems to want to say it. So good for Almodovar for framing this issue in a positive and public way. I don’t know if her “intended audience” is listening, but I hope she keeps it up.
On Fannie Mae’s corporate culture, there now are no senior executives in place with whom I overlapped during my tenure as CFO, so I’m not the best person to address this topic. But I am concerned that compensation limits imposed on Fannie’s senior officers by Congress might inhibit its ability to continue to attract and retain the talent it needs to skillfully and successfully run its operations post-conservatorship.
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Nothing stops the government from exercising the warrants while the companies are still in conservatorship. SPS & LP would still be in place. Why would there be a “need” to extend the deadline?
Perhaps a legal question for ROLG: If Treasury and FHFA decide they are going to “extend” the warrant deadline, is there any legal basis for stopping this? (i.e. in effect forcing the government to exercise the warrants)
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My personal opinion is that Treasury will not make a decision on what to do with the warrants until it decides what to do about the net worth sweep. If it has not made that decision by September 7, 2028, it would need to extend the warrants’ expiration deadline if it did not want to give them up.
The original Senior Preferred Stock Purchase Agreement, which granted the warrants to Treasury, was between Treasury and FHFA, acting as conservator of Fannie and Freddie. No one challenged the original SPSPAs legally. Were Treasury and FHFA to agree to extend the warrants it’s certainly possible that some shareholder, or group of shareholders, might challenge it. But without knowing the stated rationale for such a suit, I wouldn’t want to try to guess as to its chances for success.
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Tim
You have been waiting for the Biden Administration to act on housing? Well, wait no longer, here is the Biden plan: https://www.whitehouse.gov/briefing-room/statements-releases/2024/07/16/fact-sheet-president-biden-announces-major-new-actions-to-lower-housing-costs-by-limiting-rent-increases-and-building-more-homes/
TL;dr, it is a farce. It leads off with proposing legislation to force “corporate” landlords to cap rents at 5% pa. And open up public land not currently used for housing so that the government can build more public housing. No mention of GSEs and capital ratios, as far as I read (which I admit was not far).
This is an embarrassment, and I dont embarrass easily.
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I’ve not been “waiting for the Biden administration to act on housing;” I’ve been putting forth facts and arguments in support of my view that a Democratic administration SHOULD find it in its best policy interest to declare that past actions to put and keep Fannie and Freddie under government control were ill-advised and mistaken, and redress them by admitting that the Treasury senior preferred stock has been fully repaid and should be cancelled, that the companies should be given a true risk-based capital standard that allows them to price their credit guarantees on an economic basis, and that they should be brought out of conservatorship as quickly as possible. The senior economic officials of the Biden administrations do not seem to agree with me, and this latest White House initiative (which I have not read either, and probably won’t) appears to be more “form over substance,” similar to prior administration initiatives. That’s regrettable.
From the time I began this blog, I have tried to keep my (and others’) political opinions out of it. I will, though, say this: I am one of those who is highly dissatisfied with both parties, and presidential candidates. And I do not share the optimism in the blogosphere that a Trump presidency will be a “silver bullet” for the companies. Yes, the recommendation for them in Project 2025 is for release from conservatorship, but it’s also for “privatization,” which in the language of the Heritage Foundation (the authors of that document) means the elimination of all of their federal attributes. The Heritage Foundation has been calling for that since the Reagan administration, and it is the opposite of what the MBS vigilantes are insisting upon (i.e., a full faith and credit government guaranty). How is that going to work? Stripped of their federal charters, without paid-for PSPAs, and limited to providing credit guarantees to residential mortgages below a certain dollar amount, Fannie and Freddie would not have a competitive business (which is what their ideological opponents, including the Heritage Foundation, want). Project 2025 is not a path that leads to favorable results for current owners of the companies’ common equity, junior preferred or MBS. What, then, would be? I have yet to hear of anything I find realistic or credible.
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project 2025 advocates for release from conservatorship, but in the next sentence talks about “wind down the GSEs” so I asked them what that is supposed to mean because to my ears those statements contradict each other. still waiting for an answer.
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Michael– I wasn’t able to easily find the section in Project 2025 that talks about Fannie and Freddie (the document is almost 900 pages long, and the index isn’t helpful). But I’ve been dealing with proposals like this for more than 40 years, and the problem they have is that they are ideological and theoretical, but not informed by business or market reality. The view of the Heritage Foundation has been that if Fannie and Freddie are “freed,” it must be as fully private companies, with no government affiliation or support. I don’t expect them to change that. But Fannie and Freddie as the Heritage Foundation proposes them would not survive in the real world.
This has been the challenge of getting the companies out of conservatorship: almost all of the proposals for doing so have conditions that affect the result. Former FHFA director Calabria insisted that if the companies were freed, they had to be capitalized like banks. And while he had the power to put those capital “handcuffs” on them, he couldn’t get Mnuchin to agree to release them when they were over $400 billion short of being adequately capitalized (because of Treasury’s net worth sweep and Calabria’s capital requirement). And so it goes.
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for all interested, the relevant text is on page 706 of the PDF:
https://static.project2025.org/2025_MandateForLeadership_FULL.pdf
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Tim
Much of our lives that we construct for ourselves is informed by the narratives that we formulate for ourselves, or more likely the narratives that we adopt from our family and friends, culture, society and politics.
So at this point in the POTUS election cycle, if trying to suss out which of the two competing administrations is more likely to accomplish something constructive regarding the GSEs, it is not hard to create a narrative regarding a second Trump administration that would be more favorable to the GSEs than a second Biden administration. That Trump narrative would be based not so much on Project 2025 as the “Trump letter” produced in the Collins litigation.
Now, execution will replace narrative if and when the second Trump administration begins, and certainly if Trump appoints as FHFA director and Treasury secretary the likes of Calabria and Mnuchin, then all bets are off.
But it seems to me that if one wants a long-awaited rational resolution to the conservatorship of the GSEs, one need not venture into the realm of magical thinking to construct a narrative in which a second Trump administration, rather than a second Biden administration, is most conducive.
To me, this is not a question of party or politics, but simply observing which narrative makes the most sense.
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If we’re doing opinions, I’ll offer a couple of mine. First, I never have attached much significance to the Trump letter (nor did the courts). My view is that someone who knew Trump and was hoping to strengthen the case of the plaintiffs in the remand of the Collins case to the lower court–on the “what if” issue raised by SCOTUS concerning what might have happened had Trump had the authority to replace Mel Watt with his own director of FHFA–asked him to write that letter to Ron Paul, and because it allowed him to build on his “I can fix anything” image, he did. I realize that (many) others will disagree with me on this, but I doubt that Trump ever has had his own view on what to do about, and with, Fannie and Freddie. And that gets to the fundamental quandary any Republican president will have about them: even though on principle you oppose their being under government control, why would you want to release from conservatorship two companies your party always has opposed (at least since the 1980s, when I first came to Fannie)? Calabria’s idea was to try to do so with handicaps (gross overcapitalization and over-regulation) that would effectively offset their government advantages. And perhaps that would be the approach taken in a second Trump administration. But nobody has said anything about that yet, at least to my knowledge.
I do believe that the companies as originally chartered were a brilliant idea for using an implied government guaranty to channel valuable benefits to help low- and moderate-income Americans obtain low-cost mortgage financing on a very large scale, and thus be able to become homeowners, at no cost (and minimal risk) to the taxpayer. I thought a Democratic administration would have felt the same way. But if the Biden economic team does, they’ve been unwilling to incur the displeasure of the Financial Establishment by acting on that view, at least in their first term. Would they have more courage in a second term? Perhaps, but I can’t say I’m confident in that.
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Tim
All fair comment, although I must say you date yourself referring to Paul pere rather than fils.
There certainly is a disconnect between the historical Republican Party and the Heritage white paper (dont these folks have anything else to do?) and what seems to be emerging as a more populist/middle class/workers Republican Party. The regular folks I talk to always thought Trump talked the talk, but with Vance, they have someone now who has walked the walk at least for awhile in their shoes. So, we shall see, if Trump 2.0 occurs, whether the Financial Establishment will start complaining to deaf ears.
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You got me on the two Pauls; it shows how much attention I pay to either of them….
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Trump went along with whoever Pence brought in (Calabria). This time, we may see Vance (the new GOP) influence GSE policy. The current iteration of the party isn’t neocons and RINOs, it’s geared to a populist/working class mindset with a brilliant bench of tech entrepreneurs. Purely on IQ, Trump 2.0 administration is miles ahead of Trump 1.0. He will get Fannie/Freddie out of conservatorship. Calabria has no chance to lead FHFA. The agency itself may find itself in trouble.
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Alec,
That is an interesting and compelling take on VP activities. Assuming that is true, who do you or others think a VP Vance would appoint? I know nothing about Vance. Would any clues in his book/movie inform his posture on the GSEs at all?
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Thank you, Tim. Always very happy to read a new post, but usually sad by the end.
With the threat of a buyer strike by Pimco (and other large institutions) and I’m sure an employment blacklist that goes along with this, why would anyone in the government stick their neck out to change the status quo? Everyone has a plan and an opinion for GSEs going into the government, but here we are in 2024. Your insight feels to me to be the missing piece as to why nothing has been happening for the last decade. How does anything change?
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It’s never been easy to get things done In Washington, and even less so when that “thing” is opposed by powerful special interests. But as I’ve mentioned in previous responses to this question, what may be different in the case of the Fannie and Freddie conservatorships is that its opponents have transparently bad reasons for opposing their release. For example, Treasury claims that the net worth sweep is proper compensation for its “heroic” rescue of the companies, but there is a trove of internal documents–made available through discovery in lawsuits filed in the Court of Federal Claims–in which Treasury officials admit that the reason for the sweep was that they knew that Fannie and Freddie were about to experience a flood of net income as estimated non-cash losses booked between the fall of 2008 and the end of 2011 (including their reserves for deferred tax assets) were about to reverse, and Treasury wanted to prevent the companies from recapitalizing. That “bad fact” has been short-circuited in the courts–SCOTUS accepted an interlocutory appeal in Collins that allowed it to rule (incorrectly) on the law rather than the facts, and Lamberth did not allow the Treasury memos to be introduced in his most recent trial, deeming them to be hearsay in a case against FHFA–but those memos still exist. And I think Wall Street’s opposition to releasing Fannie and Freddie is driven mainly by the money it (and its customers) make off CRTs, which Calabria correctly called a looting of them, and which would not continue were it not for the unwarranted capital credit FHFA gives for their issuance. I think bad facts are difficult to ignore or sustain indefinitely, and that their existence ultimately will make it easier for some set of policymakers to overcome the opposition of the banks and Wall Street to a release of the companies that is so clearly merited by their financial strength and credit quality. How long that might take, though, is the question.
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Sorry, Tim. You obviously do not understand. PIMCO, Goldman Sachs, JP Morgan Chase, Bank of America, Citigroup et al. do not want Fannie and Freddie resurrected. So long as they are moribund government entities, with no hope of resurrection, the bankers who control the White House, the Senate and the Supreme Court are happy. They are not allowing any change.
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That is certainly the status quo. Two things that might change this are a broader awareness of the facts that are being ignored as Fannie and Freddie are kept in conservatorship and grossly overcapitalized, and the passage of time, which will make the negative, and avoidable, consequences of keeping them there more apparent. I note one of these in a comment below: in the past two years Fannie and Freddie’s credit guaranty business has flattened out–growing at only 1.1 percent per year, while mortgage debt outstanding has grown almost four times as fast. Non-competitive pricing, driven by excessive capital requirements, almost certainly is the reason for that. And don’t forget about the companies’ credit risk transfer programs (which former Director Calabria called a “looting” of the companies, but now sees no urgency in calling attention to the need to address)–how much longer can they go on draining capital from their issuers, and at what point will this subsidy of Wall Street by low- and moderate-income homebuyers become a political issue too blatant to ignore?
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Very insightful and important article, thank you Tim!
Makes me finally understand a bit the thinking of the “financial establishment”, and why they want to keep the status quo.
I agree that keeping the PSPAs alive but in a paid-for way would be a good choice. But given that this choice is always and still available, and, presumably, was also developed as one of several options by Calabria’s bankers, why has the Biden Administration not chosen this road?
Would the likes of PIMCO possibly agree that this solution is a good one?
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PIMCO addressed this in its comment letter to FHFA, and its answer was “no.” But the argument it gave, I thought, was very weak. Here it is:
“While some have suggested that maintaining the roughly $250 billion line of credit between the GSEs and the Treasury Department contained in the Preferred Stock Purchase Agreement (PSPA) will help ease concerns regarding an administrative exit, we would argue that is not the case. An increase in capital may comfort investors who hold equity in the GSEs, but it will not assuage MBS investors. MBS investors are focused on the guarantee of the MBS – whether their principal and interest is explicitly guaranteed or not, not the capital positions of the GSEs. Moreover, the PSPA support is subject to significant political risk: It is a bilateral agreement and contingent not only on the party in power in the White House, but the personnel who are in place at the FHFA and the U.S. Treasury Department. Moreover, the PSPA has been amended multiple times and could be further changed or eliminated at any point in the future. In other words, the impact of the GSEs’ ability to raise that capital is of no consequence to MBS investors.”
The PSPAs are not “an increase in capital,” as PIMCO asserts–they are a means of allowing Fannie and Freddie to continue to make good on their MBS guarantees even should they run out of capital. I think PIMCO was just trying to knock down counter arguments, because what it really wants is the windfall gain for their investors that an explicit government guaranty would give them. And note how in its letter PIMCO took the way Paulson actually described the PSPAs (in a quote that was given without context)–as “effectively, a guarantee on GSE debt and agency MBS”–and turned that into a transformation of the implicit guaranty into an “explicit guarantee”, italicized, which is sleight-of-hand.
As to your question, “Why hasn’t the Biden Administration not chosen this road,” I wish I knew the answer to that.
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I provided Calabria and PIMCO a link to your blog. I hope they read it.
https://x.com/GuidoPerei/status/1810744038599053755
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Tim
Thanks for this, great job as per usual. I do have a question.
In my mind, the principal advantage to re-privatization of the GSEs is the windfall profit that Treasury would garner, perhaps over $100B by my reckoning, which can be devoted to worthwhile causes, such as seeding low-income housing programs.
You say “It is shameful that no administration has yet had the wisdom, will or courage to use those facts to end the nearly sixteen-year conservatorships of two companies who, if allowed to operate their business as privately-managed entities on an economic basis, could meaningfully lower the cost of mortgage finance for millions of low- moderate- and middle-income Americans, at a time when they sorely need it.”
How would re-privatization “meaningfully lower” mortgage costs for middle-income Americans? Is it greater and cheaper access to capital, through the equity and debt capital markets as opposed to the smaller and arcane CRT market?
ROLG
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The benefit of “re-privatization” to the segment of mortgage borrowers traditionally served by Fannie and Freddie would come from both of the factors I mentioned: private management, which would bring back the market responsiveness and innovation that management by FHFA does not provide, and the ability to set guaranty fees on an economic basis (if given a true risk-based capital standard), which would significantly lower guaranty fees, particularly for higher-risk borrowers, and also make it possible for Fannie and Freddie to guarantee many more of these loans than they can currently, when the capital charge on them is so prohibitively (and unnecessarily) high.
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Tim
Thanks for reply. I suspect that few within Congress (and even FHFA) truly appreciate the cost of excessive capital levels…that the extra cost born by middle-income homeowners, due to higher guaranty fees than necessary, is insulating the returns of asset managers like PIMCO and fellow “MBS vigilantes”. As you indicate, Treasury fully understands this.
ROLG
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MBS investors (including PIMCO and Blackrock) don’t benefit from excessive guaranty fees, because they are deducted from the monthly remittances of borrowers and kept by Fannie and Freddie. It’s the banks and other portfolio lenders that buy whole mortgages who benefit; all mortgages are priced off MBS yields, so buyers of whole loans get to keep the difference between the rate paid by the borrower and the amount passed on to MBS holders (which is net of both guaranty fees and servicing). It’s the borrower who pays the cost of the excessive guaranty fees.
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TIM
I understand the pricing arbitrage. but isn’t it the MBS vigilantes view that if a sane GSE capital ratio was implemented, they would suffer a price decline on their outstanding very large guaranteed MBS holdings?
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I don’t think the “MBS vigilantes” would have much (real) reason to be against Fannie and Freddie having capital ratios that are based on risk and economics (rather than ideology or politics). Current-coupon MBS yields, and prices, are driven by the level and slope of the Treasury yield curve, and the option-adjusted spread (or OAS) of current coupon mortgages to Treasuries. The OAS, in turn, has two components: interest rate volatility (the higher the volatility, the higher the OAS) and the relative supply of MBS (the higher the amount of net MBS issuance, the greater the OAS). Of these determinants, the yield curve is by far the most important, with interest rate volatility the second most. Relative MBS supplies are third. While it IS true that over the past two years ending on March 31, 2024, Fannie and Freddie MBS outstanding only grew by 2.2 percent, while single-family mortgage debt outstanding grew by 8.4 percent (the reason, I strongly suspect, is the non-competitiveness of Fannie and Freddie’s guaranty fees because of their excessive capital requirements), current-coupon OAS haven’t tightened noticeably during that time.
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