On November 30, 2016, President-elect Donald Trump’s choice for Treasury Secretary, Steven Mnuchin, said, “It makes no sense that [Fannie Mae and Freddie Mac] are owned by the government and have been controlled by the government for as long as they have,” adding, “we gotta get them out of government control….and in our administration it’s right up there in the list of the top ten things we’re going to get done, and we’ll get it done reasonably fast.”
The first Trump administration, of course, never did. Mnuchin has not addressed this issue publicly, but former FHFA Director Mark Calabria does discuss it in his book, Shelter from the Storm, albeit briefly and vaguely, and essentially blaming Mnuchin. He states, “Secretary Mnuchin generally felt that any option had to maintain Treasury’s priority in the capital structure. Treasury could be heavily diluted, and almost certainly would have to be, but it did not want to see that accomplished by losing its standing.” Later Calabria says, “We were ready to conduct a restructuring by late summer 2020” (without specifying how they were planning to deal with Treasury’s senior preferred stock or its liquidation preference in the companies), and goes on to ask, ”[since] we had well-developed restructuring plans by late summer 2020, why did none of them happen? First, I believed both the Treasury and the White House wanted to push the issue until after the election. Since any change had the potential to create short-run volatility in the mortgage market, I believe the administration did not want to run that risk….[Then], once the election was behind us, Mnuchin’s attention clearly turned to his post-Treasury plans. Any restructuring, to be successful, would have offended somebody. We did not get it done because Mnuchin did not want to upset anyone on his way out the door, including incoming Treasury secretary Janet Yellen.”
This is just Calabria’s side of the story. The more complete version is that he and Mnuchin had different objectives for the restructuring of Fannie and Freddie that they were unable or unwilling to reconcile. More problematically, both of their objectives were based on fictions about the companies, not facts, and the institutional investors whose participation was essential for the recapitalization of Fannie and Freddie knew this. Mnuchin seemingly wanted Treasury to be repaid twice for 2008 “rescues” the companies did not request and did not need, while Calabria was insisting on “hard wiring” the entirely arbitrary 80 percent increase in required capital he had imposed on Fannie and Freddie in December of 2020, creating a severe handicap for their business. The investment community was being asked to bear the cost of both of these non-economic objectives, which was unreasonable to expect it to be willing to do.
During the Biden administration, Treasury Secretary Yellen and FHFA Director Thompson showed no interest in addressing Fannie and Freddie’s conservatorships. Yellen simply was silent on the matter, while Thompson repeatedly said she would defer to Congress to solve the problem through some unspecified type of legislative “reform.” But the companies have been reformed. They no longer are allowed to hold mortgages in portfolio as investments—which had been the main objection to them prior to the conservatorships—and along with primary lenders are subject to the “ability to repay” provision of the 2010 Dodd-Frank Act that prohibits the toxic loan types and lending practices that triggered the 2008 financial crisis. Moreover, Fannie and Freddie’s entity-based business model—in which revenues on good loans from all years, regions and loan types are available to cover losses on any loans that go bad—is already far superior to the senior-subordinated model used in private-label securitizations (PLS). In the PLS model, each pool must stand on its own, and the inability to reach beyond it for revenues, or add capital post-securitization, requires substantial initial subordination, which translates into much higher credit guaranty costs and still leaves the holders of the senior tranches exposed to losses that exceed the fixed loss-absorbing capacity of the subordinated tranches. Fannie and Freddie’s credit guaranty model is the gold standard.
So now, the second Trump administration is inheriting two companies that together finance 48 percent of the $14.1 trillion of single-family mortgages in America, have been extremely profitable for the last dozen years and need no further reform, yet because of policy choices made during previous administrations remain mired in conservatorships that would take them almost 15 years to emerge from on their own, during which time their current degree of overcapitalization would continue to prevent them from providing affordable mortgage financing to the low- moderate- and middle-income families they were chartered to serve.
Are there any reasons to believe that the new Secretary-designate of the Treasury, Scott Bessent, might have better luck in “getting them out of government control” than Steven Mnuchin did? In fact, there are, because of all of the changes in Fannie and Freddie’s circumstances and condition that have occurred over the past eight years.
Perhaps most significantly, at the end of 2016 Treasury still was institutionally committed to “winding down and replacing” Fannie and Freddie legislatively, as it had been since before Secretary Paulson put them into conservatorship. This goal was driving Treasury’s policies toward the companies, as memorialized in a December 12, 2011 Draft Internal Memorandum for Treasury Secretary Geithner, containing “a plan with FHFA to transition the GSEs from their current business model of direct guarantor to a model more aligned with our longer-term vision of housing finance.” Components of this plan included guaranty fee increases that would continue “until pricing reaches levels that are consistent with those charged by private financial institutions with Basel III capital standards” (irrespective of risk), a single securitization platform for Fannie and Freddie (which could be used by their successors or competitors), securitized sharing of credit risk (which the memo said “would likely reduce the earnings capacity of the GSEs”), and “faster retained portfolio wind down.” All of these were done. This same memo also contained a proposal to “Restructure the calculation of Treasury’s dividend payments from a fixed 10 percent annual rate to a variable payment based on available net worth (i.e., establish an income sweep).” That, of course, was done as well, eight months later, and it became known as the net worth sweep.
But after the November 2018 midterms, which moved the House of Representatives under Democratic control, virtually the entire financial community, along with Treasury, gave up on the idea of trying to replace Fannie and Freddie. Numerous efforts—including the first Corker-Warner bill in 2013, Johnson-Crapo in 2014, and what was called “Corker-Warner 2.0” early in 2018—all had flaws that prevented them from generating any momentum, and a divided Congress was the final blow to the aspirational notion that it might be possible to create a viable alternative to Fannie and Freddie legislatively. Removal of the companies from conservatorship would need to be done by administrative action. And here is where the problem arose. As I wrote in a January 2020 post titled How We Got to Where We Are, “the fictions about Fannie and Freddie that were essential elements of the attempt to replace the companies in a legislative process become impediments when the goal is to successfully recapitalize and release them in an administrative process.”
In his book, On the Brink, Secretary Paulson falsely says,“Fannie and Freddie were the most egregious example of flawed policies that inflated the housing bubble and set off the financial crisis.” Throughout the first ten years of the companies’ conservatorships, that was the version of them repeated by the financial media—and Treasury—and the $187 billion in Treasury senior preferred stock Fannie and Freddie had drawn between 2008 and 2011 was universally viewed as the cost to taxpayers of their profligacy. Very few knew the true story, until more than two dozen shareholder suits were filed against the net worth sweep, beginning with Perry Capital v. Treasury and FHFA in July of 2013.
The amicus curiae brief I submitted for Perry Capital in July of 2015 highlighted the facts that were coming to light in these cases. I noted that both Fannie and Freddie had been in compliance with their capital requirements when Paulson asked their boards to acquiesce to his conservatorship request, and that more than all of their $187 billion in senior preferred stock (which Treasury had made repayable only with its permission) was the result of over $300 billion in noncash expenses booked by FHFA as conservator that either were temporary, advanced from future periods, or based on estimates. And I pointed out that Treasury and FHFA had imposed the net worth sweep just before the majority of those noncash expenses reversed and came back into income ($158 billion in 18 months), so that the resulting revenues went to Treasury, rather than enabling Fannie and Freddie to rebuild their capital. (For those interested in the full set of facts about the conservatorships and the net worth sweep, I recommend my Supreme Court amicus written for Collins v. Yellen.)
In July 2017, the judge in another case against the net worth sweep, Fairholme Funds v. The United States, in the Court of Federal Claims, released 33 documents produced in discovery that made clear that Treasury was not being truthful in its public explanation for the sweep, which was that it was done to save the companies from a “death spiral” of borrowing to pay the dividends on their senior preferred. Not only did these documents reveal that Treasury and FHFA were fully aware that Fannie and Freddie were about to enter “golden years of earnings” just as the sweep was being imposed, there also were memos among Treasury staff making blatant admissions such as, “By taking all of their profits going forward, we are making clear that the GSEs will not ever be allowed to return to profitable entities at the center of our housing finance system” [emphasis in original]. Finally, and more recently, in August 2023, a jury hearing a remand of Perry Capital (now Fairholme Funds v. FHFA) in the U. S. District Court for the District of Columbia found that FHFA “wrongly amended” the Senior Preferred Stock Purchase Agreements when it agreed with Treasury to impose the net worth sweep, and awarded plaintiffs damages plus interest totaling $831 million to date (to be paid by the companies, which have accrued their respective portions).
As a hedge fund manager, Treasury Secretary-designate Bessent should be aware of the plaintiffs’ (correct) version of the Fannie and Freddie story, and if he is not there will be people with whom he is close who can tell him. Knowing the facts should make Bessent more likely to concede that Treasury’s $193.4 billion in senior preferred stock in the companies is fully repaid (as it has been), and to agree that it should be cancelled, along with Treasury’s liquidation preference ($341.0 billion at December 31, 2024, and growing each quarter). Yet should he insist that payments made to Treasury under the net worth sweep are not repayments of the senior preferred—and that the companies should pay Treasury again by having its senior preferred converted to common stock—he at least will be cognizant that this stance will make the recapitalization of Fannie and Freddie much more challenging, because their investors will know that they are not being treated fairly.
Deeming Fannie and Freddie’s senior preferred to have been repaid, and cancelling it and the liquidation preference, will put the companies firmly on the path towards release. But to get to that release point more quickly—and to deliver on the Trump campaign’s pledge to reduce the cost of homeownership for ordinary Americans—Treasury and FHFA also must undo the damage to Fannie and Freddie’s credit guaranty business caused by the punitive and unjustified Enterprise Regulatory Capital Framework (ERCF) imposed by former FHFA Director Calabria. New information about Fannie and Freddie’s risk, and the “Calabria capital standard,” also has become available over the past eight years, and that should make tackling and resolving this issue easier for Bessent than it proved to have been for Mnuchin.
Most important is Fannie and Freddie’s continued improvement in their annual Dodd-Frank stress tests. In the last test made available before Mnuchin was appointed Secretary, Fannie required initial capital of 79 basis points to survive a stylized 25 percent decline in home prices, while Freddie required 156 basis points. For the test run in 2020, when Calabria put out his ERCF for comment, Fannie required no capital to survive a 28 percent drop in home prices, while Freddie required 31 basis points. Since then, neither company has required any initial capital to survive their Dodd-Frank stress tests in 2021, 2022, or 2023, and the 2023 test subjected them to a 38 percent decline in home prices. (Curiously, FHFA delayed releasing the results of the 2024 stress tests beyond its August 15 deadline, “so that the Enterprises may provide additional supporting information and analysis of the scenarios, that the Director of FHFA may deem necessary,” but since the 36 percent home price drop in the 2024 test was slightly less than in 2023, it’s safe to assume the companies required no initial capital to pass the 2024 test either.) In sharp contrast, the average risk-based capital requirement for Fannie and Freddie of the Calabria standard—purportedly calibrated to a lesser degree of stress than the Dodd-Frank tests—was 4.27 percent of their total assets at September 30, 2024.
Why is the Calabria capital requirement so much higher? Because it’s purely arbitrary, and not based on risk at all. Rather than create a true risk-based capital requirement for Fannie and Freddie and then set a minimum capital requirement consistent with that, Calabria did the opposite. He began by setting a “bank-like” minimum capital requirement of 4.0 percent for the companies (despite the fact that they have no business in common with banks), then used three contrivances—not considering guaranty fees in the risk-based capital stress test as absorbing credit losses, artificially increasing capital on all loans though add-ons, buffers and cushions, and subjecting low-risk loans to a minimum risk weight—to engineer a result for the required amount of Fannie and Freddie’s “risk-based” capital that was greater than his arbitrary minimum of 4.0 percent. (A much more comprehensive discussion of this topic can be found in the September 2021 post Capital Fact and Fiction.)
The impact of this gross overcapitalization has been severe. Fannie has been most affected by it, because the ERCF imposes a graduated capital surcharge for financing more than 5 percent of outstanding single-family mortgages (a “stability capital buffer”), and Fannie is larger. Since the ERCF took effect in the first quarter of 2022, its stability capital buffer has averaged 30 basis points more than Freddie’s (at September 30, 2024 it was 111 basis points of Fannie’s total assets).
A comparison of selected financial data for Fannie between the five years before the ERCF took effect (2017-2021) and after is telling. In the five years prior to the ERCF, Fannie’s guaranty fee on new single-family business averaged 46.5 basis points (not including the 10 basis points it has to charge and remit to Treasury); because of the ERCF that average fee has steadily risen to 54.1 basis points in the third quarter of 2024. We saw in the mid-2010s that when Fannie’s average guaranty fee on new business exceeded 50 basis points, the growth in its single-family business stalled out. The same is happening now. After growing by 3.0 percent in 2022, Fannie’s single-family book shrunk slightly (by 0.1 percent) in 2023, and it has continued to shrink in the first three quarters of this year. As a consequence, while Fannie financed 27.8 percent of outstanding single-family mortgages at December 31, 2021, it financed just 26.1 percent as of June 30 this year (the latest date for which totals on outstanding single-family mortgages are available).
The impact of Fannie’s pricing also is evident in securitization shares. During 2017-2021, Fannie issued an average 39 percent of all new single-family MBS; Freddie and Ginnie Mae each issued 29 percent, and the other 3 percent were issues of PLS. But in the third quarter of 2024 Ginnie Mae was the leading issuer of single-family MBS, at 37 percent; Freddie was second at 28 percent, Fannie third at 27 percent, and the PLS share had risen to 8 percent.
Less evident, but more dramatic, has been the sharp drop in Fannie’s credit guarantees to borrowers with less-than-perfect credit (who typically have lower incomes). Here the relevant base of comparison is pre-conservatorship, and the last five years when Fannie had a “normal” profile of new business acquisitions—before underwriting standards were distorted by originations destined for private-label securitization—which was 2000-2004 (also my last five years as Fannie’s CFO). During that period, the average credit score of all single-family loans Fannie purchased or guaranteed was 715, and 36 percent of its business had a credit score under 700. By comparison, during the first nine months of 2024 Fannie’s average credit score on new business was 759, and a mere 10 percent of that business had a credit score under 700. That is a plunge of over 70 percent in what are predominately affordable housing loans. This, too, is the result of pricing, particularly the feature of the ERCF that does not consider guaranty fees to absorb losses. Because of that, the credit “risk weight” of a loan with a 90 percent loan-to value ratio and a credit score of 660 results in required capital of 945 basis points. And when you add in the additional percentages for management and operations risk, and the stress and stability capital buffers, Fannie’s total required capital on a 90 LTV, 660 credit score loan is 11.50 percent, requiring the company to charge a guaranty fee of 125 basis points to earn a return on capital comparable to what it’s earned on its average credit guaranty portfolio so far in 2024. That’s preposterous.
None of these trends are going to improve as long as the ERCF remains in effect. And what has been happening with Fannie also is reflected in national housing trends. Earlier this month the Washington Post published an article that reported, “Between July 2023 and June 2024 the share of first-time home buyers in the market was only 24 percent — a historic low.” It also said, “The share of home buyers paying all cash reached 33 percent through August this year, according to data from Redfin — one of the highest rates since the years following the Great Recession,” and added, “As cash purchases have become more common, the median age of home buyers…now stands at 56 years old,” compared with 39 years old in 2008 (when Fannie and Freddie were put into conservatorship). The high all-cash share of homebuyers, and their increased average age, are flip sides of mortgage costs that are unaffordable to younger potential homebuyers with decent but not great credit. This is a real problem, and getting Fannie and Freddie out of conservatorship with capital requirements based on economics rather than ideology would be a real solution, which the second Trump administration could take credit for.
What prevented Treasury Secretary Mnuchin and FHFA Director Calabria from delivering on Mnuchin’s November 2016 pledge to get Fannie and Freddie out of government control was the inability of the former to get comfortable with ending (not just suspending) the net worth sweep and eliminating Treasury’s senior preferred stock and liquidation preference in the companies, and the intransigence of the latter in making the release process much more difficult by insisting on nearly doubling their capital requirements at the same time as their credit risks were falling and their revenues soaring (as reflected in the results of their Dodd-Frank stress tests). The lessons from this failure, plus a fresh face at Treasury, should ensure that these mistakes aren’t repeated in “Release 2.0.”
Something else that won’t happen with Bessent as Treasury Secretary is “privatization” as defined by the Heritage Foundation in Project 2025. For most people, privatization means the return of Fannie and Freddie to shareholder ownership. But the Heritage Foundation’s definition of privatization is stripping Fannie and Freddie of all of the federal attributes in their charters, while leaving their business restrictions intact. The companies would not survive in that state, as the Heritage Foundation implicitly admits with its recommendation that, “Fannie Mae and Freddie Mac (both GSEs) must be wound down in an orderly manner [and] the Common Securitization Platform should be privatized and broadly available.” In other words, run off $7.3 trillion in Fannie and Freddie’s single- and multifamily mortgages and hope they can be re-issued as private-label securities. That is a disastrous prescription by academic theoreticians with no market experience, and Bessent will treat it as such.
More likely, in my view, would be for Bessent to arrive at a strategy for the release of Fannie and Freddie through an analytical process similar to what I outlined in my September 2023 post, An Easy Way Out:
“As Treasury evaluates ending the net worth sweep and allowing Fannie and Freddie to exit conservatorship, it will need to determine which of its claims on them [its senior preferred, liquidation preference, and warrants] have the most value. And that will not be hard. To get value out of its $120.8 billion of senior preferred stock in Fannie and $72.6 billion of senior preferred in Freddie, Treasury will have to convert them into each company’s common stock. Yet the very act of doing so will reinforce investors’ strong views of unfair treatment. They know Fannie and Freddie have repaid their senior preferred, with dividends; it’s just that Treasury has used its non-repayment provision as a reason not to count net worth sweep remittances as repayments. Treasury’s insisting that its senior preferred be converted to common would be requiring the companies to repay their senior preferred twice. If it does, how many investors would choose to buy Fannie or Freddie common stock again—including the stock Treasury would need to sell to get value from converting its senior preferred—and how much would they be willing to pay for it?
Now consider the alternative: making Treasury’s warrants for 79.9 percent of Fannie and Freddie’s existing common stock more valuable by making the companies more valuable. Here, Treasury would work with FHFA and the administration’s senior economic team to negotiate a recapitalization and release agreement that includes retroactive cancellation of the non-repayment provision of the senior preferred and a recasting of the companies’ remittances under the net worth sweep as repayments of the senior preferred stock (which would pay all of it off for both). Fannie and Freddie, in return, would agree to accept utility-like return targets on their credit guaranty business, benefitting homebuyers. Then, for its part, the administration would acknowledge the criticisms made by commenters on FHFA’s request for input on Fannie and Freddie’s capital and pricing, and strongly encourage (or require) FHFA to remove the excess and unwarranted conservatism in the ERCF, to have it more closely reflect the true risks of Fannie and Freddie’s business.”
An Easy Way Out also suggests a “quick fix” to the ERCF that would not require a full re-working of the rule immediately: “to drop the ‘prescribed leverage buffer’ Calabria added to the 2.5 percent minimum capital requirement FHFA set for the companies in its 2018 capital standard, and then remove enough of the non-risk-based minimums and buffers in the ERCF’s risk-based component to reduce it to below the 2.5 percent minimum, which would become the companies’ binding capital requirement for the foreseeable future.” In conjunction with that, of course, Treasury and FHFA would cancel or replace the January 14, 2021 letter agreement between Mnuchin and Calabria setting 3.0 percent CET1 capital as the threshold for ending the companies’ conservatorships.
Deeming Fannie and Freddie’s senior preferred to have been repaid and canceling the net worth sweep and the liquidation preference, and giving the companies a true risk-based capital standard and a reasonable minimum capital percentage, would be a “win” for all parties. The biggest winners would be the millions of low- and moderate-income Americans who once again would have a large-scale source of low-cost mortgage credit to help them achieve their dream of homeownership. But not far behind would be Treasury, whose stakes in Fannie and Freddie would become a great deal more valuable were the companies to be treated fairly, returned to private management, and structured to succeed.
HOWARD ON MORTGAGE FINANCE 
Do you believe that Pulte’s decision to create a new LLC to hold Common Securitization Solutions tech and sell MBS Fin Tech Services to others will have a material affect on the GSEs?
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I’ve not been following this closely, but it seems that so far all FHFA has done is to rename CSS “U.S. Financial Technology.” Still to be determined is what comes next. Will FHFA have Fannie and Freddie sell the services of U.S. FinTech to third parties, such as the issuers of private-label securities, or spin it off entirely, then have Fannie and Freddie contract with it to run their securities issuance programs? I think the latter would not be wise. The real value to the government of Fannie and Freddie is the warrants it holds for 79.9 percent of the companies’ common stock, which could be worth a very large amount of money if Treasury structures their release in the right way. Things like selling off the former CSS would weaken that value, so in my view they would be short-sighted.
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Tim,
With so much buzz and constant tweets from the new FHFA head, and the various TV rodeos and the info he shares, am very surprised that your blog comments section is stale after March
Would like to get your perspective on how you see things unfolding based on everything that is being shared by FHFA and the POTUS
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I’ve been a little surprised by the lack of activity in the comments section, too, but I think it’s likely because the followers of my blog (a viewership that’s down by over half since the June 2021 SCOTUS ruling in Collins) know that I have a policy of not accepting comments from people who just want to express their personal opinions–they need to provide some insight or new information worthy of sharing with others. And I haven’t felt any need to do a new post, since the current one gives my advice to the Trump economic team on how they should think about and execute Fannie and Freddie’s recapitalization and release, and also includes links to two fact-based pieces–my Supreme Court amicus and “Capital Fact and Fiction,” which explains the origin and flaws of former FHFA director Calabria’s ERCF standard.
I do have some thoughts on “everything that [has been] shared by FHFA and the POTUS” recently. The most basic is that the future of Fannie and Freddie has been “teed up” by FHFA director Pulte, Secretary of the Treasury Bessent and even the president in a way that makes it almost certain that SOME affirmative decision on them will be made in the foreseeable future. It’s also become clear to me that while the final decision will be made by Trump, Secretary Bessent and his team at Treasury will provide valuable substantive input on the alternatives, while Director Pulte will view his role as executing whatever it is Trump decides to do. This perspective has made me less concerned about some of the contradictory (or counterfactual) things Pulte has been saying in his many public appearances.
Asked by a Bloomberg reporter on May 23 about Fannie and Freddie “privatization” (following their “nationalization”), Bessent said, “It is a goal for this administration. Again, we’re doing peace deals, tax deals, trade deals, so as we land some of those deals then we will focus on that. But what I can tell you, we are doing a great deal of studying at Treasury because the one requirement, the one requirement for this privatization is that they are privatized in such a way that mortgage spreads do not widen, and in fact is there a way that we can make the spread between the risk-free rate and mortgages tighten as Fannie and Freddie are privatized.” When asked if there was a way to do that, Bessent said, “Sure. There are several ways to do it, and we are exploring it.” I don’t think it was coincidental that four days later President Trump posted on Truth Social, “I want to be clear, the U.S. government will keep its implicit GUARANTEES, and I will stay strong in my position on overseeing them as President.”
As I’ve written both in recent comments and in my previous post, The MBS Vigilantes, the argument from opponents of Fannie and Fannie release that doing so without an explicit government guaranty on their securities will cause mortgage spreads to rise never has had any merit. Post-conservatorship, the companies retain the important indicia in their federal charters that gave rise to investors’ perception of that implicit guaranty, and since 2008 the addition of an explicit line of credit in the form of the PSPAs, the doubling of the companies’ guaranty fees and halving of their credit risk (as reflected in their needing no initial capital since 2021 to pass FHFA’s severely adverse stress tests) and their being required to exit their on-balance sheet portfolio business only should have strengthened that perception. But in The MBS Vigilantes, I did note “should investors need reassurance about…the agency status of the companies’ debt and MBS, an affirming word from Treasury would provide it.” The May 27 “affirming word” on this subject from the POTUS was even better, and ought to put to rest any fears that baseless objections to Fannie and Freddie’s release from conservatorship by the MBS vigilantes might keep it from happening.
As to what WILL happen, I’m still betting on a resolution close to what I recommend in my current post (which is very similar to the recommendation from Bill Ackman, who knows both Bessent and the POTUS). IF maximizing Fannie and Freddie’s value to taxpayers–as Pulte keeps insisting upon–is indeed a key administration objective, the only way to do that is to deem Treasury’s senior preferred to be repaid and cancel its liquidation preference, which will make the 79.9 percent of the companies’ common stock for which it holds warrants much more valuable than 99 percent of the common stock it would own if it converted the seniors to common, then had to try to sell that common to the investors it had just wiped out. Bessent knows this, and I also think he knows he has to do something about Calabria’s ERCF. The risk-based component of the ERCF is not risk-based at all; it is entirely the result of unreasonable assumptions (mainly that guaranty fees from loans that survive the credit stress do not absorb any losses), cushions, buffers, minimums and add-ons, and was concocted to produce a “bank-like” percentage of over 4% by a FHFA Director who didn’t think the companies ought to exist. Then there is the practical matter that the status quo requirement for releasing Fannie and Freddie from conservatorship is that they have common equity tier 1 (CET1) capital equal to 3% of their adjusted total capital for two consecutive quarters. As of March 31, 2025, they were $330.4 billion below that threshold, and even were the Treasury seniors to be cancelled they still would be $131.6 billion below it (and $195 billion short of “adequate capitalization” under the risk-based component of the ERCF). I have little doubt that Bessent (perhaps with an assist from Ackman and others) will understand the folly of asking investors to underwrite anywhere close to that amount of new equity just to hit punitive capital bogeys created by a director whose goal was to severely handicap them.
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Thanks Tim for your valuable insight
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I agree with all of this Tim, but I want also to propose a way for us to understand Pulte’s assertion on CNBC that the “GSEs may go public while still in conservatorship”…which seemed to confuse many investors.
this relates to the ERCF and the notion bandied about during Trump 45 that the GSEs would enter into a consent decree which would transition an exit from conservatorship by means of an agreement, whereby the GSEs would continue to accumulate capital subject to restraints on ability to distribute dividends and declare executive compensation bonuses/stock grants.
I suspect what is being debated in Trump 47 is what the terms of this consent decree would be. for Pulte to assert that there would be primary offerings for the GSEs (or as Pulte says, going public) while still in conservatorship, or having satisfied neither the ERCF nor Treasury/FHFA amended PSPAs, indicated to me the prospect of an off-ramp from conservatorship via consent decree, with conservatorship not being finally terminated until the consent decree is fully satisfied.
just trying to translate Pulte-speak.
ROLG
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ROLG–I think you may be trying a little too hard here.
The consent decree talked about under the first Trump administration would have been an agreement reached among Treasury, FHFA and the companies that would have transferred the management responsibilities for Fannie and Freddie to their boards and senior executives, subject to the restrictions and constraints contained in the decree which would have been removed when each company hit some specified target for capitalization. But with Director Pulte now serving as Chairman of both companies (against the limitation in HERA that “The Director and each of the Deputy Directors may not…hold any office, position or employment in any regulated entity…”), a consent decree is of little value to potential shareholders. While FHFA could try to raise equity for Fannie and Freddie under such circumstances, I believe there will be very poor participation from investors until shareholders have been put back in a position where they elect the companies’ boards of directors, the boards select their chairs, and the chairs choose the senior executives who will run the companies in shareholders’ (not the conservator’s/regulator’s) best interest. Yes, trying to raise equity (or “going public” in Pulte’s phrasing) for Fannie and Freddie while Pulte is still Chairman IS an option for Treasury and FHFA to consider, but it’s not a very good one if they want to raise significant amounts of equity on favorable terms.
And while I’m at it, let me also make a couple of comments about Director Pulte’s frequent mentions of the need to reduce fraud and waste in the mortgage finance system.
From the announcement about Fannie Mae contracting with Palantir to detect fraud in the loans it buys or guarantees, it appears that FHFA’s intent is to use the secondary market companies, Fannie and Freddie, to detect fraud that takes place in the primary market. The companies don’t underwrite loans themselves; they have underwriting requirements and guidelines that they ask primary lenders to make representations and warranties that they have followed when they sell or ask for credit guarantees on those loans. Fannie and Freddie then do “post-purchase reviews” on a small sample of the loans, and when they find fraud on a loan they require a lender to repurchase it. I don’t know at this point whether FHFA’s intent is to just enable Fannie and Freddie to expand the scope of and do a more comprehensive job on their post-purchase reviews (although the companies’ extremely low credit losses over the past dozen years suggest that undetected fraud has not been too serious a problem for them), or if it wants them to be the fraud detectors for the primary market (something which, when I was Fannie’s CFO, would have engendered strenuous objections from the Mortgage Bankers Association as “mission creep.”)
As for possible “bloated expenditures” at the companies, I’ll note that between the end of 2008–right after the conservatorships began–and the end of 2024, Fannie’s administrative expenditures have grown at an average annual rate of 3.8 percent, and they grew only slightly faster, by 4.2 percent per year, during the four years of the Biden administration. In comparison, over the last five years for which there are data–2018 through 2023–the regulatory assessments of FHFA on Fannie, Freddie and the Federal Home Loan Banks have grown at an average annual rate of 9.1 percent.
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Tim
I dont know what being Board chairman gets Pulte that he didn’t already have as FHFA Director, except possible exposure to personal liability for breaching the statutory provision you cite. But what we have been witnessing recently is the absence of Bessent commentary and Pulte trying to fill the gap, to no one’s benefit.
As for Trump’s social media post on continuance of implied guarantee, perhaps that was Bessent telling Trump that it was better coming from POTUS than Treasury Secretary.
ROLG
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Thanks Tim. I learned a lot from your book and continue doing so through your articles and comments.
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Tim – The reason may not be seeing much activity here is people are unable to post or like anything. I even changed my password without success. I was about to give up after many attempts and hit the subscribe button which it said I was already subscribed. I tried one more time to like something and it finally worked. If this reply goes through problem solved for me but wanted to let you know I was about to give up again after many attempts for the past couple of years.
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Yesterday the Fed voted 5-2 to lower one of the capital requirements for the largest banks.
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If you or your readers are interested, we are going before a three-judge panel at the Federal Circuit on May 9th at 10:00am. This is the largest, unrequited Fifth Amendment Takings case in United States history.
https://drive.google.com/file/d/1rzRaKkB428pJyTxhhN5MNgcL0ZOAFrwS/view
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Good luck with your oral argument!
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Any update from yesterday?
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I haven’t read any analysis of yesterday’s oral argument in the Fisher case, but I listened to the recording of it this morning, and my reaction was that plaintiffs are unlikely to succeed in their attempt to overcome res judicata (issue preclusion), because their substantive argument for a derivative takings claim is essentially the same as what Fairholme counsel argued in its direct claim; Fairholme lost that direct claim, and when it then filed for cert with SCOTUS on the derivative claim, cert was denied. That, to me, seems like “Game Over,” leaving no legal path for Fisher counsel to get their argument on property rights heard again–which they are seeking to do because of their interpretation that the SCOTUS decision in Tyler (which came after Fairholme lost its direct case on appeal) strengthened their argument that the net worth sweep WAS a taking, so they would like that argument to be re-heard.
Bryndon–who’s obviously much closer to this than I am–may have a different take (I hope so).
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Tim – any thoughts on the shakeup at the GSEs?
Not wasting any time following his Senate confirmation last week, Federal Housing Finance Agency (FHFA) Director Bill Pulte made a series of major changes to the boards of government-sponsored enterprises Fannie Mae and Freddie Mac according to filings with the Securities and Exchange Commission (SEC). The news was first reported by Inside Mortgage Finance.
Based on the SEC filings, the Freddie Mac board removals included six members including board chair Lance Drummond, and Jane Prokop, who joined the board on Jan. 7. Pulte installed himself as board chair, who joins the board alongside Brandon Hamara, Clinton Jones and Ralph “Cody” Kittle.
At Fannie Mae, eight members were removed but CEO Priscilla Almodovar will remain onboard, as will existing members Renée Lewis Glover, Karin Kimbrough, Manuel Sánchez Rodríguez and Scott Stowell. Michael Heid, the former chair, has been removed. The new appointees include Clinton Jones, Christopher Stanley (of Elon Musk’s SpaceX) and Michael Stucky. Pulte will also serve as chair of Fannie Mae’s board.
“Freddie Mac will provide information regarding any related party transactions and the new directors’ committee assignments as they become known,” the Freddie filing said, while for Fannie the board has yet to finalize any board assignments for the new members.
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It’s obvious that new FHFA director Bill Pulte has some changes in mind that he wants to make at Fannie and Freddie while they remain in conservatorship. And–based on the presence of Christopher Stanley as a new director on both companies’ boards, along with Pulte’s observation on Fox News that only 49 of Fannie’s 2900 people were present at its headquarters building when he toured it yesterday (which I find hard to believe)–it seems that reducing staffing is one of those changes.
But I’m a little puzzled by that. Fannie and Freddie have two of the lowest ratios of administrative expenses to pre-tax net income of any company in America (17.0% at Fannie and 19.2% at Freddie), and the salary component of that is even lower (9.4% and 11.3%, respectively). All of Fannie and Freddie’s salaries can be covered by 6 basis points of single-family guaranty fees, so even cutting staff by 33 percent (which would be ruinously deep) would save only 2 basis points of fees. The unnecessary elements of conservatism, cushions, buffers, minimums and add-ons in Mark Calabria’s ERCF cost the companies ten times that amount in guaranty fees. How about removing that gross inefficiency first? Moreover, the total cost of Fannie and Freddie’s money-wasting CRTs (over $4 billion per year) exceeded their combined $3.67 billion in annual salary costs in 2024. Why not allow Fannie and Freddie to do CRTs only when they make economic sense?
I’m hopeful that once Pulte and Treasury Secretary Bessent have time to speak with more people who understand how Fannie and Freddie work, they will realize that not all corporate inefficiencies come from overstaffing.
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Tim
Your point is well taken, that the two main drivers of future cost reduction/profit maximization at the GSEs are stopping CRTs and defanging the ERCF, and G&A expense presents a much thinner opportunity. Perhaps the time is not yet right to attack those two larger opportunities, as Pulte finishes the first week on the job, while focusing on employee costs is now ripe (as Doge is in the spring air).
But I see this as a recurring theme: companies increase their operational efficiency by going digital, but don’t make the employee and staff cuts that are available to them by virtue of the digital implementation.
Musk famously found that 80% of the employees at X were not needed simply because the X platform could work on its own. What was needed by way of employee focus was improving the X platform, not sitting by and watch it do its thing.
I get the sense that Pulte is “Musk-approved”. I also wonder whether, in an age where borrower can secure a mortgage that travels to a GSE MBS pool all without pen touching paper, it might be high time for Pulte to ask the Musk question of GSE employees, “What exactly do you do here?”.
I just hope Pulte does likewise at FHFA.
ROLG
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Since Fannie and Freddie pay directly for all of FHFA’s staff and expenses, it certainly would make sense for Pulte and his team to look at those, too.
It’s been over 20 years now, but when I was at Fannie it was not easy for department or division heads to get authorization for additional headcount at budget time. I had a broad span of control over Fannie’s finance and risk management activities, and if anyone ever had asked me to do even a 5% across the board headcount cut I would have responded by saying I would not be able to do that without compromising the effectiveness or reliability of the work we were doing. Perhaps things have changed since then, but I hope Pulte listens to the top management at the companies before forcing large staff cuts to compete with what DOGE is doing with government agencies.
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Tim
“Since Fannie and Freddie pay directly for all of FHFA’s staff and expenses, it certainly would make sense for Pulte and his team to look at those, too.”
Since you raise the point, FHFA has statutory authority under HERA to receive only payment of FHFA’s budgeted expenses, plus an additional amount for necessary working capital.
During conservatorship, FHFA has amassed over $150,000,000 in so-called working capital, that sits in an FHFA account at Treasury. Since FHFA doesn’t engage in financial transactions like the FDIC, I can’t imagine that FHFA’s working capital needs exceed $10,000,000.
FHFA should remit back to the GSEs this money that it has skimmed from the GSEs. Pulte is on my clock to do just that.
ROLG
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ROLG–I agree that $150 million in FHFA working capital seems very high. But the piece of this I don’t have is when Fannie and Freddie pay their annual assessments to FHFA. According to their 10Ks, in 2024 Fannie paid $164 million in FHFA assessments and Freddie paid $137 million, for a total of $301 million. I doubt that they pay these amounts all at once, but if they did there would be a period of time during the year where FHFA’s “working capital” would be well above $150 million, and it would be drawn down as FHFA incurred its annual expenses. But if Fannie and Freddie pay quarterly or more frequently, then I agree; it would be hard for FHFA to justify ever having $150 million of their money on its balance sheet.
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FHFA begins staff cuts
https://www.govexec.com/workforce/2025/03/housing-agencies-begin-closing-offices-escorting-employees-out/403903/
ROLG
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Tim,
Hugh Frater was on Urban Institute’s zoom call this week and said the enterprises expense base relative to the overall book is 1/2 fees that go to the gov’t and 1/2 fees for the enterprises, totaling 16bps. He mentioned there is a lot of opportunity to cut costs.
Where do you think the costs could be streamlined?
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Alec (and others)–Hugh is right that Fannie’s expense base is 16 basis points of its adjusted total assets (17 basis points of its total assets), and that about half of that ($3.77 billion) is determined by the government and half ($3.62 billion) by Fannie. Virtually all of the government’s piece of Fannie’s expenses is the 10 basis points Fannie has had to charge and remit to Treasury on all its credit guarantees since the Temporary Payroll Tax Cut Continuation Act was passed in 2011, and foolishly extended in 2021. The other $324 million are for Fannie’s annual FHFA assessment ($164 million), Treasury’s Capital Magnet Fund ($56 million) and HUD’s Housing Trust Fund ($104 million). Fannie can’t cut any of that. Of the $3.62 billion it does control, $2.00 billion goes for salaries and benefits, and the other $1.62 billion is described in its income statement as going for “professional services, technology and occupancy.”
I listened to the UI panel this week, and did not hear Frater say there was “a lot to cut” at Fannie. But if he did, he was there less than three years ago and I haven’t been there for over twenty, so I wouldn’t argue with him. I would, though, stick with a version of the point I made on this issue a couple of days ago–namely, even if you took 20% out of Fannie’s controllable expense base, that would only be 2 basis points of total assets. The $1.87 billion Fannie spent just in 2024 for CRTs it said had a lifetime expected benefit of $117 million was 4 basis points in one year, or a present value of about 20 basis points, and Fannie also could take at least 20 basis points out of its single-family guaranty fee by removing the arbitrary conservatism, cushions, buffers and add-ons from Calabria’s ERCF. There just isn’t that much opportunity to make a meaningful impact on Fannie’s bottom line by cutting expenses.
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Christopher Stanley just resigned from Fannie Board.
Does FHFA need 800+ employees for really essential work? 100 may be enough.
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Tim,
Thank you for helping us to understand the GSEs better over the years.
Judge Lamberth’s decision has come out. He decided in favor of Plaintiffs. Do you have any opinion on this and how it may affect the ultimate release of the companies?
Thank you in advance.
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I view this (long-delayed) decision by Lamberth to be unrelated to and independent of the “ultimate release of the companies.” But it will be informative to see if FHFA, under its new director, Bill Pulte, appeals it.
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Tim
I was piqued by Quishuang’s (unsourced) comments below regarding Treasury’s recoupment of $25B from fraud litigation brought on the GSEs’ behalf by FHFA as conservator, and so I did a little research, which led to a (free) substack post. I set forth a link to it below:
https://ruleoflawguy.substack.com/p/fhfa-recovered-25-billion-on-behalf
ROLG
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you could ask GSE Investor Relations departments for exact amounts of all the settlements.
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Tim,
Fannie Mae released its annual report (10K) for 2024.
Fannie’s President & CEO Priscilla Almodovar’s statement on Fannie’s most recent press release reads …
“Fannie Mae concluded the year with a strong quarter, generating net income of $4.1 billion, and $17.0 billion for the year. In 2024, we grew our net worth to nearly $95 billion, continued to build our regulatory capital, and carried out our mission.
Our strong results were driven by guaranty fee income, consistent with the
transformation of our business model that began well over a decade ago. For the year,
we provided $381 billion in liquidity to the U.S. housing market, helping 1.4 million households buy, refinance, or rent a home.”
It looks like another good year for Fannie … I was wondering if you have had a chance to take a look at the 10-K and if so what is your take?
As always thanks for all you do!
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There were a number of aspects to Fannie Mae’s 2024 10K that were notable, one being notable for what was not there.
The first is that Fannie’s net revenues in 2024 were up only slightly from 2023—rising from $20.0 billion to $20.1 billion. There were three factors at work here. The first is that the growth in Fannie’s credit guaranty business has flattened out; its single-family book of business actually fell by 0.8%, so that even with 6.4% growth in multi-family credit guarantees and a 14.1% jump in the size of Fannie’s retained portfolio (more than all of it due to mortgages held for “lender liquidity” purposes), Fannie’s total book of mortgage loans barely increased (by 6 basis points) during the year. And while its average charged fee on new single-family business was 54.1 basis points in 2024 compared with 53.2 basis points in 2023, the positive effect of this increase was largely offset by a continued slowing in the rate of amortization of Fannie’s deferred guaranty fees (at December 31, 2024, some 63% of its mortgages had note rates under 4%; these are prepaying slowly, and should continue to do so).
A surprise that acted to boost Fannie’s 2024 net income was that it still took a $938 million benefit for single-family credit losses, even though its single-family delinquency rate has been rising since the spring and it had $464 million in net single-family loan write-offs during the year. At December 31, 2024, Fannie’s $5.32 billion single-family loan loss allowance was only 15 basis points of its conventional single-family book of business. This is very low, and it appears to be a result of Fannie’s having to follow (along with everyone else) the “Current Expected Credit Loss” accounting standard adopted by the FASB in 2016, which is strongly pro-cyclical. It is a virtual certainty that for the foreseeable future Fannie will be providing for, rather than benefiting from, its loan loss allowance, and this will be a depressant to its earnings rather than a boost to them.
A third aspect of Fannie’s 2024 earnings worth noting is the very large contribution made by the growing amount of its shareholders’ equity (or net worth), which at December 31, 2024 was $94.66 billion. At June 30, 2019, just before the net worth sweep was suspended, Fannie’s net worth was only $6.37 billion. Shareholders’ equity is interest-free funding, allowing the company to either add assets without incurring any debt cost, or to replace debt that had been on the books in earlier periods. A comparison of Fannie’s balance sheet of June 30, 2019 with December 31, 2024 shows that Fannie has used about 38 percent of its $94.66 billion in net worth to add short-term assets, and 62 percent of it to replace long- and short-term debt. At current asset yields and debt costs, this interest-free funding was responsible for $3.8 billion of Fannie’s 2024 pre-tax earnings, and $3.0 billion of its after-tax earnings. In the first half of 2019—with just $6.37 billion in net worth and interest rates on short-term debt and assets effectively at zero—the contribution to earnings of Fannie’s interest-free funding was negligible.
The aspect of Fannie’s 2024 10K that was notable for what wasn’t there was in the section titled “Credit Risk Transfer Transactions.” Both a chart and a table breaking out Fannie’s CRT transactions by type—CAS, CIRT and lender risk-sharing—and giving the CRT costs by those breakdowns that had been in the 10Ks since 2019 were omitted, without explanation, from this year’s 10K. To get data on Fannie’s CRT costs, one now has to go to three places. The “Summary of Consolidated Results of Operations” table shows $1.641 billion in credit enhancement expense, with a footnote adding that this figure “excludes CAS transactions accounted for as debt instruments and credit risk transfer programs accounted for as derivative instruments”. Those can be found elsewhere in the 2024 10K, and their costs are $148 million and $82 million, respectively, bringing Fannie’s total cost of CRTs in 2024 to $1.871 billion. Fannie did continue to publish its expected benefit from CRTs in the 2024 “Credit Risk Transfer Transactions” section, in a “Single-family Credit Enhancement Receivables” table. This showed $117 million as “the benefit we expect to receive” from “Freestanding credit enhancement receivables” (i.e., all credit enhancements excluding private mortgage insurance, which is paid by the borrower). So, it now takes more piecing together, but one still can derive from Fannie’s 10K the current economics of its credit-risk transfer program: in 2024, it was a cost of $1.871 billion PER YEAR to obtain a LIFETIME expected benefit of $117 million. That is beyond non-economic. Those who continue to tout Fannie’s CRTs as an innovation in credit risk management either don’t read the company’s financial reports, don’t understand them, or do read and understand them but choose to ignore the facts about CRTs that (badly) contradict the story they want to tell about them.
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Thanks again Tim ….
The CRT story continues to amaze, fingers crossed that new management will right ship and quit giving away the company’s money in this bizarre credit risk management scheme.
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And remember, back in May of 2021 FHFA published a report on Fannie and Freddie’s CRTs, in which it did a simulation of their performance under two sets of conditions, a “Baseline scenario” and a “2007 replay”. In the baseline scenario, CRTs cost Fannie and Freddie $30 in interest payments for every $1 in credit losses absorbed, and even in the 2007 replay the companies still paid $3 for every $1 dollar in credit losses transferred. To make matters worse, FHFA also reported on how well CRT investors did in these two cases: they were “projected to receive a simple return of about 26 percent on the original reference pool UPB in the baseline scenario and 16 percent in the 2007 Replay.” FHFA’s reaction should have been to shut the CRT programs down immediately, but instead it said it needed to “study the issue further.”
Before he left FHFA, Director Calabria said he realized CRTs “were structured to almost never pay” and he called them a “looting” of the companies, but he didn’t do anything about them. Neither did Director Thompson. I think the only way they can be stopped is by Fannie and Freddie themselves, after they’re released from conservatorship with a true risk-based capital standard, and allowed to make decisions on credit enhancement mechanisms themselves, based on their economics (not a desire to carry favor with Wall Street firms and investors by funneling massive amounts of money from the companies to them via CRTs).
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Reply 2.0
Cmdr Ron Luhmann
The HOLY GRAIL Summary of the Fannie/Freddie story ! absolute BEST summary of WHAT REALLY HAPPENED ! if you listen to ANYTHING – carefully Listen to THIS PODCAST !
youtube.com
Keith Jensen on Fannie & Freddie’s Release: A Boost for Homebuyers
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I haven’t listened to this podcast–and likely won’t be able to get to it until sometime tomorrow–but I have approved it for the blog to give readers a chance to see it here.
(9:40pm update) I was able to listen to this late in the afternoon, and I thought Jensen made an effective presentation, certainly in comparison with what I’ve heard on other podcasts.
One point where I believe he had it wrong, however, is when he said that after Fannie and Freddie are released they will be able to help lower mortgage rates by buying more loans for their mortgage portfolios. The Senior Preferred Stock Purchase Agreement (SPSPA) required both companies to shrink those portfolios to no more than $250 billion, and each now has a much smaller portfolio than that (at year-end 2024, Fannie’s was $94.9 billion, while Freddie’s was $101.0 billion), and they use them only for purposes incidental to their credit guaranty business. Pre-conservatorship, the companies’ debt-funded portfolios were “lightning rods” for their critics, and (even as the person who was responsible for Fannie’s on-balance sheet portfolio for 17 years) I can’t imagine them being allowed to get back into that business post-conservatorship.
I also noted that Jensen had been premature when he said that the argument for the rating agencies potentially downgrading Fannie and Freddie if they were released without an explicit government guaranty on their MBS “went away” when Fitch said it believed there would be “no change” in their ratings in that case. Last Thursday, on a panel sponsored by The Urban Institute, Warren Kornfeld of Moody’s said that in his view a release without an explicit government guaranty would cause his agency to take a “bottom-up rather than a top-down” approach to the companies’ rating, likely resulting in a one- to three notch downgrade from AAA. While Kornfeld gave no quantitative rationale for this speculation, his contention will require a counter. I’ve suggested that a senior Treasury invite Kornfeld to Washington and ask him some version of the following question: “How is it that prior to the conservatorships Moody’s gave Fannie and Freddie AAA ratings with only their charter attributes (the “implicit guaranty”), but if they are released from conservatorship with no change to those charter attributes—and with the government having made good on the implicit guaranty of their debt and MBS in 2008, Treasury’s addition of the SPSPA backstop, and with the companies today having half the credit risk and double the guaranty fee rates as they had pre-conservatorship—Moody’s now would rate them below AAA?”
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Hi Tim,
David Fiderer wrote a jeremiad on Twitter re: ‘The Big Lie’ concerning the GSEs’ role in the great financial crisis—if you’re interested in seeing it: https://x.com/Ny1david/status/1898096355807314128. While some may quibble with his polemical style (everyone who advances a different position from his is not merely wrong but a ‘liar’, for example), Fiderer points to many factors that help explain the durability of the misconception that the GSEs were responsible for the crisis and their continued poor reputation in many quarters (including among policy makers).
You have stated you will not have this blog turned into a gripe session where people air out their complaints about the world, the treatment the GSEs have received, and the recalcitrant wrongheadedness so many exhibit re: Fannie & Freddie. So, I won’t rehash Fiderer’s position (most of which will be pretty familiar to most readers of this blog, anyway). But I was interested in one point Fiderer made re: fraud:
“Fraud- The GSEs do not originate mortgages; so anyone who says the GSEs contributed to pervasive mortgage fraud is a liar”
I’m sure you’re loathe to second guess others or to retrospectively assess decisions made many years ago that don’t have the benefit of hindsight. Still, I wonder if a) you think that assessment is right—do you think the GSEs can be completely absolved of contributing to mortgage fraud (whether ‘pervasive’, ‘significant’, or ‘moderate’)?, and b) do you believe Fannie would have engaged in similar practices prior to the GFC had its leadership team (specifically CEO Raines and you) been retained rather than dismissed in 2004?
I’m also wondering what your sense is regarding the general perception those currently in positions to affect the (near-term) future of the GSEs regarding what Fiderer calls ‘The Big Lie’ and Fannie & Freddie’s past and future role in the economy.
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FHFA sued large banks on behalf of GSEs, alleging the bank misrepresented quality of MBS sold to them. Treasury, not the real victims, collected $69.4B directly. I think this money was not counted as “dividend” payment to Treasury.
Summary of Settlements: $69.4B
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Q
can you provide source link? thanks!
ROLG
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I’m not on “X” (formerly Twitter), but either David Fiderer or someone else sends me pretty much everything he writes or posts (sometimes in draft form). His writing style is different from mine, but I’m glad he’s so committed to getting the facts about Fannie and Freddie out into the “Twitterverse.” I think he’s doing valuable work.
It’s always hard to generalize, but I would agree with David’s statement that Fannie and Freddie should not be characterized as “contributors to pervasive mortgage fraud.” Offhand I can’t recall of any specific incidence of fraud that has been attributed to either company, and there is a good reason for that: as credit guarantors, they have no incentive to perpetrate mortgage fraud; to the contrary, they would be the likely victims of it. It’s true that when I was there Fannie did at times fail to detect fraud committed by originators or mortgage sellers–and lost money because of it–but that’s a different matter.
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Calabria is now an Asso Director at OMB. The info below may alleviate some people’s concern.
The OMB (Office of Management and Budget) does not directly supervise the FHFA (Federal Housing Finance Agency), but it does have certain oversight and coordination roles related to the FHFA, similar to other independent agencies.
Here’s how the relationship works:
To summarize, while the OMB plays a role in overseeing administrative aspects, such as budget reviews and regulatory assessments, it does not directly supervise the FHFA’s day-to-day operations or its specific policy decisions, as the FHFA is an independent agency.
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Tim
you and your readers may want to register and virtually view this event, to keep tabs on the opposition:
https://www.urban.org/events/recapitalizing-gses-through-administrative-action-impact-mortgage-rates-and-mbs-market
Recapitalizing the GSEs through Administrative Action: Impact on Mortgage Rates and the MBS Market
Virtual Event
Thursday, February 13, 2025, 11:00 a.m. to 12:00 p.m. ET
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Treasury Secretary Bessent’s statements to Bloomberg on Thursday that “Anything that is done around a safe and sound release [of Fannie and Freddie] is going to hinge on the effect of [sic] long-term mortgage rates”–and that the “most important metric” he is looking at is any study indicating that those rates would go up–marked the official start of the lobbying effort by opponents of release to convince him that mortgage rates WILL rise if Fannie and Freddie are allowed to exit conservatorship without an explicit government guaranty on their mortgage-backed securities (MBS). Since The Urban Institute already is on record taking this position, the only reason to listen to its “panel of experts as we explore whether there is risk of downgrade and diminution of liquidity and how a potential GSE restructuring would affect investor demand for Fannie Mae and Freddie Mac MBS” will be to see if they’ve been able to come up with any new justifications for their pre-determined conclusion. I’ll likely tune in for that reason, since it will be important to have convincing counter-arguments for Bessent on this issue when he does turn his focus to Fannie and Freddie sometime after his current priority, which he says is tax policy.
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Tim,
Does Bessent’s background or financial acumen give you reason to believe he’ll see through the false narrative regarding rising rates due to recapitalization and release?
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Bessent’s background and financial experience will be a plus in making this assessment, but because the nature of the implicit guaranty of Fannie and Freddie’s MBS is such an arcane subject, I suspect it will be hard for him not to find the large number of “serious people” saying the same (false) things about it to be persuasive. That’s why it will be important for the advocates for Fannie and Freddie release to first point out (without rancor) the competitive reasons many of these opponents have for taking the positions they do, but then to also have substantive arguments that are compelling enough that Bessent gets to where he believes that the risk of an adverse market reaction to releasing Fannie and Freddie is extremely low, and that, critically, Treasury itself has a great deal of control over that risk through what it does and says about the implicit guaranty, and the paid-for backstop, when it releases the companies.
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Tim, will you be an active participant in this lobbying effort?
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I will be active in preparing papers (and, at the appropriate time, very likely a blog post) on the sustainability of the agency status of Fannie and Freddie’s MBS (and debt) post-conservatorship, but I wouldn’t call what I’ll be doing “lobbying.” I don’t represent any interest; I see my role as providing facts and sound analysis to those who DO have an interest–along with a position I agree with–and also have access to the principal decision makers.
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On Thursday, MBA held a briefing at the U.S. Capitol for House and Senate staffers to discuss the potential for a release from conservatorship for the GSEs. The included a link to their presentation deck, where they demanded a Explicit Backstop that should be on MBS only. They say that this backstop should cover tail risk only: After PMI coverage, After Credit Risk Transfer, and after GSE Reserves and Capital, and that this backstop should be paid for by GSEs. To do this, they suggest utilizing existing commitments under the PSPAs (charging a commitment fee), creating an FDIC-style insurance fund (ala Johnson-Crapo) or similar, paid-for explicit guarantee, and utilizing Ginnie Mae to provide an explicit guarantee on GSE MBS and charge current or other guarantee fee.
There seems to be a “vibe-shift” towards inevitable release, but with all the focus now on the demand for this kind of Backstop. I guess my two questions are: 1) Is it necessary, and 2) Will it happen?
MBA Advocacy Update: MBA Holds GSE Briefing on Capitol Hill; FHFA Nominee Pulte Support Letter; Bessent Confirmed as Treasury Secretary, More – MBA Newslink
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Shane
As things stand now, the GSEs have a line of credit from Treasury plus the GSEs’ capital, which has been substantially enhanced over the past 4 years since GSE recap/release was last discussed. It seems the MBA, Mr. Zandi and others are fine with the status quo.
After recap/release, GSEs will have a line of credit from Treasury (which will be paid for) plus the GSEs’ capital which, given the GSEs’ $25 billion of annual cash flow, will continue to increase.
Why the need for a third party explicit MBS guarantee after recap/release, when there is no call for it now?
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The MBA should have a legend on the bottom of its letterhead saying “Official trade group of the Financial Establishment.”
As I and others have said repeatedly, making an explicit government guaranty on Fannie and Freddie MBS the sine qua non for their release from conservatorship is the best strategy the Financial Establishment has for trying to prevent release from happening–since there is no chance Congress would approve it–so that’s what it’s going with.
But I’m also struck by the FE’s depiction of the federal agency status of Fannie and Freddie’s securities as some incredibly fragile perception that any change in the status quo could upset. There actually was a “stress test” of that perception, more than 20 years ago, and the companies’ agency status passed it with ease.
This occurred shortly after the anti-Fannie and Freddie lobbying group, FM Watch, was formed in the spring of 1999. Less than year later, a Louisiana congressman named Richard Baker–who was chair of the Capital Markets Subcommittee of the House Banking and Financial Services Committee, and had fully embraced the FM Watch cause–introduced a bill with provisions that were highly unfavorable to Fannie and Freddie. Then-Treasury Secretary Larry Summers sent his undersecretary for domestic finance, Gary Gensler, to testify at the hearing for Baker’s bill (which had little support even in his subcommittee), at which he dropped two bombshells: that Treasury was in favor of a provision in the Baker bill that would have repealed its $2.25 billion “line of credit” with the companies, and that Treasury also thought “Congress should seriously consider the best way to repeal” the exemptions Fannie and Freddie securities had from banks’ investment securities limits.
There was an immediate and violent market reaction to these statements–with the prices of Fannie and Freddie debt and MBS plummeting, and their spreads to Treasuries soaring. Treasury quickly backed off. Almost certainly at Summers’ direction, Gensler put out a statement the following afternoon saying that his testimony “was consistent with longstanding principles in this area,” and that “it does not represent a change in the government’s relationship with the GSEs.” But of course, Treasury WAS trying to change the government’s relationship with Fannie and Freddie; it just backed off when it got the market blowback. And the fact that market participants had taken Treasury’s word that its policy toward the companies hadn’t changed even when that wasn’t true strongly supports the notion that if Treasury were to release them with their federal indicia (including the two Gensler had proposed removing) intact AND with a paid-for backstop under the SPSPA–and coupled that by saying this “does not represent a change in the government’s relationship with the GSEs”–the market certainly would believe THAT.
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https://www.breitbart.com/economy/2025/01/23/breitbart-business-digest-the-trump-administration-is-not-going-to-release-fannie-and-freddie/?utm_source=substack&utm_medium=email Likely cause of share price fall today.
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We will see many more articles like this, from sources that earn their living by writing pieces that advocate for, and assert the inevitability of, whatever it is the Financial Establishment wants. Banks benefit from higher interest rates on the mortgages they hold in portfolio as a result of originators having to build in non-economically high guaranty fees to their primary market mortgage quotes; MBS issuers and investors want to use exit from conservatorship as a lever for getting Congress to agree to an explicit government guaranty on Fannie and Freddie MBS (which will never happen), and Wall Street and the investment community are more than happy to have the companies remain under FHFA control in conservatorship, issuing CRTs that (along with CIRTs and ACIS done with mortgage insurers) cost over $2 billion per year in interest payments while potentially transferring only a small fraction of that amount in credit losses to CRT buyers (who earn very attractive returns as a result). These all are very powerful constituencies.
As to the substance of Carney’s article, he puts forth his own (speculative) theory that HERA allows FHFA to put Fannie and Freddie into conservatorship but not take them out. But that flies in the face of common sense. Regulators place regulatees into conservatorship if they think they can be rehabilitated; if they can be they exit conservatorship, and if they can’t be they go into receivership. Fannie and Freddie clearly have been “rehabilitated,” and then some. FHFA conservatorship is not a roach motel (you can go in but you can’t get out).
The rest of Carney’s article is just a “checking of the boxes” of all the standard criticisms: mortgage rates will rise if Fannie and Freddie are privatized without any government support (that’s not what’s being contemplated); their securities must have an explicit government guaranty to avoid rating agency downgrades (I counter this one in my January 15 response to the Parrott-Zandi article); cancelling the Treasury senior preferred stock and its liquidation preference is a giveaway of taxpayer money (it’s not; as discussed in the current post and in An Easy Way Out, the best way for Treasury to maximize the value of its claims on the companies is to cancel the senior preferred and liquidation preference, then recapitalize them on an economic basis and release them, making the value of its warrants for 79.9 percent of their common stock more valuable); and executing a plan similar to what Bill Ackman has proposed would result in a windfall to hedge funds for which the Trump administration would be punished politically (ordinary investors own more Fannie and Freddie common and preferred stock than the hedge funds do, and Treasury would make four times as much money on ITs holdings of Fannie and Freddie common than all of the other existing common shareholders, including the hedge funds, would.) But Carney and others are going to keep repeating these arguments, because that’s how they put food on the table.
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Thanks Mr. Howard – Years of John Carney has been pain and seemingly right until Lamberth’s 9 jurors said different. Thanks for your input “Fannie and Freddie clearly have been ‘rehabilitated,’ and then some.” Your experience is much appreciated.
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[Edited for length] Speaking of putting food on the table, Mark Zandi did a recent podcast with The Monetary Matters Network you may find interesting. https://youtu.be/Nn9VXEvee0M?feature=shared (Most of my quotes in quotation marks are verbatim, but a couple may be paraphrases).
Zandi’s position boils down to: first, do no harm. If you can’t do that, then leave it alone. (and it’s impossible to improve on the status quo without an explicit guarantee).
He argues that the GSEs have been in conservatorship for a full generation and they’re functioning just fine. Where ‘just fine’ means their ability to “get mortgages to American families”.
His position is interesting in that he argues that releasing the GSEs from conservatorship is a horrific risk that would have massive destabilizing effects in the market (the only open question is just how bad the destabilizing effects would be, not that they’d happen) while on the other hand maintaining that the current function of the GSEs is essentially risk free.
When he wants to highlight the lack of a need to change anything, Zandi points to the amazing innovation and creativity the GSEs have shown in conservatorship. “They’ve invented the credit risk transfer market, which means that they’ve unloaded the risk they take. Which means they’ve effectively been privatized already—private investors are taking the credit risk, not the GSEs themselves.”
The rosy picture of terribly innovative, creative, and risk-free GSEs, though, seems to be completely undone at the mere mention of the phrase ‘administrative reform.’ Zandi avers that every proposal (and it’s clear he thinks every *possible* proposal) for administrative reform makes things worse. He says how much worse is up for debate, but there can be no doubt that administrative reform will:
As a result, we are compelled to leave the GSEs where they are “until we get a window to legislative reform to codify reforms”, which include an explicit governmental guarantee.
I’m sure many would be interested to hear your thoughts on Zandi’s positions—especially his belief that the companies are already private (by dint of off-loading risk to private entities) and that the taxpayer won’t net any economic benefit from a public offering of the GSEs.
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Zandi is arguing for the indefinite continuation of the status quo for Fannie and Freddie, because that is what his client base wants. There are no positive arguments to be made for this, so he, and others, fall back on “be afraid, be very afraid” of any change to the status quo that doesn’t give the companies’ securities an explicit government guaranty. There is, of course, no chance Congress ever will give Fannie and Freddie’s securities such a guaranty. And I’ve given my arguments as to why the fears of what might happen in its absence are unfounded, both in my post The MBS Vigilantes and in the comment I made on this site about the Parrott-Zandi Urban Institute paper on January 15. This issue, however, isn’t going be settled by dueling newspaper or blog articles and podcasts, or by hand-to-hand combat on “X.” The Secretary of the Treasury, Scott Bessent, and the Director-designate of FHFA, Bill Pulte (who almost certainly will be confirmed), will listen to and analyze both sides of the argument, and make a decision as to what to do with Fannie and Freddie based on their views of the merits. And that is as it should be.
But I do want to address the two statements Zandi makes in the podcast that Fannie and Freddie in conservatorship are “working just fine,” and “they’ve invented the credit risk transfer market, which means that they’ve unloaded the risk they take.”
As I note in the current post, the status quo enshrines former FHFA Director Calabria’s hugely excessive and completely arbitrary ERCF capital requirement, which causes the companies to greatly overprice the guaranty fees they have to charge the affordable housing borrowers they were chartered to serve—and I give the example of a 90 percent LTV 680 credit score loan for which the ERCF makes Fannie charge a guaranty fee of at least 125 basis points, more than double what it should be. As a consequence of this, single-family homes that should be affordable to Fannie and Freddie’s traditional borrower base are instead being bought up by private equity firms who purchase them with the cash they get from investors, then rent those homes to people who otherwise would have had a chance of owning them themselves, and building equity for their children and grandchildren. What’s “working just fine” about that?
And it is baffling to me that someone as financially literate as Zandi would not be aware (or choose not to admit) that FHFA itself told us back in the spring of 2021 how wildly non-economic Fannie and Freddie’s CRTs are. They don’t transfer risk; they transfer revenue, at the companies’ expense, and weaken them financially. (Should readers have any doubts, I would encourage them to read, or re-read, the post I did on FHFA’s “Performance of Fannie Mae’s and Freddie Mac’s Credit Risk Transfer” report right after it came out: https://howardonmortgagefinance.com/2021/05/ ). When released from FHFA control in conservatorship, and given a true risk-based capital standard, Fannie and Freddie will be free to stop issuing these blatant giveaways to the investor community.
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Hi Tim,
Thank you so much for this. How does the incoming administration affect the 2023 lawsuit win. Has there been any update on this?
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The change in administration should not have any effect on the status of the Fairholme Funds v. FHFA case still in front of Judge Lamberth in the U.S. District Court in the District of Columbia, but then I have an almost perfect record of predicting the outcomes of Fannie and Freddie legal cases incorrectly. And I’ve read or heard nothing new about the Lamberth case for several months.
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Tim, what is your perspective on Trump’s nominee for Director of FHFA, Bill Pulte?
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I had not heard of Bill Pulte until today, but I think background matters. He runs a private equity fund, so he will be financially savvy, and also have a predisposition to facts over “accepted thought” or ideology when it comes to Fannie and Freddie. I’ve also heard, but have not confirmed, that he is a friend of Bill Ackman, which would be a positive if true.
And I would contrast President-elect Trump’s appointment of Pulte today to Trump’s nomination of Mark Calabria to head FHFA in December of 2018. Calabria was a known opponent of Fannie and Freddie. I knew of his views on the companies from an essay he wrote for an Urban Institute project called the “Housing Finance Reform Incubator” in the spring of 2016, titled “Coming Full Circle on Housing Finance.” (I also wrote an essay for that project, which I titled “Fixing What Works.”) In his essay, Calabria called securitization “a false god that failed us”–confusing the limited senior/subordinated form of credit protection done at the pool level in private-label securitizations with the full corporate capital at risk in the entity-based credit guarantees offered by by Fannie and Freddie–and he advocated a “return to an originate-and-hold model of mortgage finance.” His recommendation for Fannie and Freddie was that “the current GSE charters should be converted to national bank charters and the GSEs reorganized as bank holding companies.” As Director of FHFA, Calabria could not give Fannie and Freddie bank charters, but he could, and did, burden them with bank-like capital requirements–which bore no relationship to the risk of the only business they are allowed to do–in his ideologically motivated ERCF.
As I said, background matters. Pulte strikes me as a promising choice as head of FHFA, given where Fannie and Freddie now are in their “long, strange trip.”
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tim
very interesting that you heard that Ackman and Pulte may have a relationship, perhaps concerning philanthropy. please update if you can confirm.
my relief is that Pulte is not what I refer to as a “capital nerd”. some transplant from FDIC or the Fed for example. working out the correct risk capital weights can delight those on the spectrum but it does little for housing/mortgage finance.
in the meantime before Pulte’s confirmation, the FHFA director position will become vacant on 1/20/25 and can only be temporarily filled by someone outside FHFA who has already gotten Senate confirmation, or by someone currently inside FHFA.
if anything is to be accomplished on the recap/release front early in Trump 47, I suppose it will be POTUS/Treasury directed.
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ROLG– I’ll try to get confirmation on (or refutation of) an existing relationship between Pulte and Ackman.
[10:00 am update] I’ve had more than one person tell me that Pulte and Ackman are friends, and have received the added “color” that Pulte Homes is the builder on a number of projects by the Howard Hughes Corporation in Las Vegas, with Ackman being heavily involved with the Howard Hughes Corp.
But precisely because Pulte is not a “capital nerd,” and IS a finance person, I suspect he would be receptive to the idea I put forth in a comment I made on December 10, addressing how a 2.5 percent minimum capital requirement for Fannie and Freddie might be made effective relatively quickly: “to declare that the ERCF is irreparably flawed, and that until it can be re-done and re-proposed Fannie and Freddie’s 2.5 percent minimum capital requirement from the 2018 rule will be in effect as long as the companies’ annual Dodd-Frank stress tests result in a level of initial required capital of 1.5 percent or less.” This solution would be clean, elegant, and rely on existing work already being done by FHFA (the annual stress tests), so it would be difficult for the internal FHFA bureaucracy to argue against.
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Tim
There are two important assumptions to Ackman’s forecast of an intrinsic value for FNMA of $31.81/sh as of 2026 year end: recap/release with 2.5% equity capital standard adopted, and SPS eliminated.
There are other assumptions which might be a tad questionable (such as only 10% haircut to intrinsic value in public offering, which I don’t believe gives credit to Treasury’s 79.9% overhang), but focusing on the big two assumptions, either these prove right or Ackman has egg on his face.
Pretty courageous to put out a public presentation on X with these assumptions (both logical but highly uncertain), but perhaps his courage has been stiffened by private knowledge.
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ROLG–“Recap/release with 2.5% equity capital standard adopted, and SPS eliminated” are what I have been recommending for several years now, so I’ll be the last to be critical of that. As to these assumptions being “pretty courageous,” I’d use another term to describe them: fact-based. I understand that facts may not matter where politics, ideology and competitive advantage are involved, but if you want to successfully get the companies out of conservatorship, you’ve got to do it in a way that makes economic sense. The alternative–which is what the Financial Establishment and the “MBS Vigilantes” are for–is to keep them in conservatorship indefinitely. I know which side of that fight I’m on.
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I’m replying to ROLG’s mention of Ackman’s public discussion of his idea.
History repeats itself here and Ackman is known to put his ideas out there in public. He did basically the same thing during the General Growth Properties Ch. 11 process (that’s what led to his involvement w/Howard Hughes Holdings – HHH was spun off to GGP shareholders).
I remember reading his GGP presentation during the bankruptcy……and it was “spot on”.
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@distress
I agree re GGP, but I also recall Ackman putting out a public deck/presentation on the GSEs early in Trump 45. Not once burned, twice shy. Good for him.
ROLG
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Tim, I was wondering if you’ve had a chance to look at the latest piece prepared by our friends Jim Parrott and Mark Zandi and published by Urban Institute ?
https://www.urban.org/research/publication/fannie-and-freddies-implicit-guarantee
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Yes, I have, and I must say that I was very disappointed that The Urban Institute allowed its name to be attached to a piece that is so obviously and blatantly biased. Anyone who has followed the court cases against the net worth sweep knows that one of the UI article’s authors, Jim Parrott, was a primary instigator of the sweep, and that he knows it was done not for the reason Treasury stated, but to keep Fannie and Freddie from recapitalizing (as documents produced in discovery by the Court of Federal Claims prove). This should have disqualified him for UI as someone who could write objectively on this issue.
As for the substance of the article, I addressed many of the issues it raises in my previous blog post, “The MBS Vigilantes.” But here I’ll focus specifically on the UI article. Parrott and his co-author, Mark Zandi, contort themselves to mischaracterize the “implicit guaranty” investors associated with Fannie and Freddie’s debt and MBS before the conservatorships. As one who experienced this first hand (as the CFO issuing Fannie debt), investors viewed a handful of the federal indicia in Fannie and Freddie’s charters—the authority of the U.S. Treasury to purchase $2.25 billion of their debt at its discretion, an exemption from state and local taxes, the eligibility of their debt for purchase by the Federal Reserve in open market operations, and for unlimited investment by national banks and most state banks and thrifts, and their designation as government securities under the 1933 and 1934 SEC Acts—as evidence that the government would not let them lose money on the companies’ debt or MBS (athough they could on their equity). And in fact, Treasury’s actions when it forced Fannie and Freddie into conservatorship proved those beliefs to have been valid.
And Parrott and Zandi are simply incorrect when they state that the conservatorship “finally [made] the implicit guaranty explicit.” Treasury Secretary Paulson went to great lengths NOT to do that; instead, he made agreements between Treasury and Fannie and Freddie, “acting through the Federal Housing Finance Agency….as conservator,” that created a line of credit the companies could draw on. These Senior Preferred Stock Purchase Agreements (SPSPAs) were ON TOP OF, and supplements to, the agency indicia investors previously had viewed as conveying an implicit government guaranty. And because the SPSPAs are agreements between Treasury and the companies, they do not sunset when the conservatorships end. The only agency indicium Fannie and Freddie lost in the 2008 HERA legislation was the exemption of their equity from SEC registration requirements (they retained those exemptions for their debt and MBS), but they already had been complying with that requirement on a voluntary basis.
Parrott and Zandi seek to confuse readers by noting, and mischaracterizing, the two ratings Fannie and Freddie historically have been given. The first is the AAA/aaa rating associated with their “implicit guaranty,” and the second is what originally was referred to as a “risk to the government” rating–essentially a rating of the government’s exposure to loss were Fannie or Freddie to fail. The first such rating given to Fannie by S&P, in 1997—when it had a large on-balance sheet mortgage portfolio—was AA-. Today, with no portfolio, and with current annualized pre-tax earnings of $21 billion and a credit portfolio that requires no initial capital to survive a 38 percent decline in home prices, Fannie’s risk to the government rating would have to be even higher. This should strengthen, not weaken, the case for maintaining AAA/aaa ratings on the companies’ debt and MBS.
But Parrott and Zandi turn the actual situation on its head, by asserting that, “Once the GSEs are released from conservatorship, the rating agencies would reintroduce the dual ratings, and if they assume the GSEs have no implicit government backstop, some would downgrade them to the lower stand-alone rating.” Why, though, would the rating agencies assume Fannie and Freddie “have no implicit government backstop” if they were released from conservatorship? With the SPSPAs, which the companies would begin paying for, they have an EXPLICIT backstop from Treasury, in an amount far more than they ever might need (and, of course, the draws they made during the crisis were forced on them by FHFA booking massive amounts of non-cash expenses). Moreover, Fannie and Freddie still have all of the critical agency indicia that gave rise to the original investor perception of an implicit government guaranty, AND they’re now more than twice as profitable and have less than half the credit risk as before the conservatorships. By every objective measure, Fannie and Freddie’s AAA/aaa ratings should be maintained post-conservatorship. And, as I said in “The MBS Vigilantes,” should investors need any reassurance about the maintenance of the agency status of Fannie and Freddie’s securities, “a word from Treasury would provide it.”
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https://www.fhfa.gov/document/letter-agreements-and-side-letter-executed-by-ust-and-fhfa.pdf
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This exchange of letters, dated today, between Treasury Secretary Yellen and FHFA Director Thompson appears to be an expression of their position that the status quo for the conservatorships, and the ERCF, should be enshrined indefinitely. (I have not yet been able to cross-compare the amendments referenced in these letters with the original documents, to determine exactly what was changed, and try to evaluate why.) The new Secretary of the Treasury and FHFA Director will be able to supersede these letters, but I’m still surprised that Yellen and Thompson felt the need to issue them. I wonder whose interests they believe they are serving by having done so. Certainly not the interests of lower income people who can’t afford the guaranty fees Treasury and FHFA are making the companies charge, for no economic reason.
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@nope
18 days before their authority expires, and after almost 4 years after having done nothing re GSEs, Treasury and FHFA still do nothing, but apparently think they have. I couldn’t think of a more ineffectual pair than Ms. Thompson and Yellen.
ROLG
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I scanned through the letters (but admit I haven’t compared to the original agreements). The letter seems to enshrine the ERCF, perhaps preventing it from being thrown out quickly (requiring long-winded amendment process). The side letter seems to be trying to make ending the conservatorship harder by mandating studies, briefings and presidential decisions. My guess is that they are worried about the Trump administration moving quickly and decisively (both unlikely in Washington regardless of administration). For them, the status quo works well. The Trump team will have to fight “the blob” on this issue.
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Janet Yellen received several letters on the facts about Fannie and Freddie’s conservatorships (some including links to or copies of posts I wrote on this blog), but it appears she either didn’t read or didn’t believe them. With this exchange of letters and side letter, she and Ms. Thompson appear to be taking the side of what I termed the “MBS Vigilantes” in my previous post, and others, who claim that mortgage rates will soar if Fannie and Freddie are released from conservatorship without an explicit government guaranty on their securities. As I wrote in the post, that claim is self-serving and untrue, but it seems to have found a sympathetic audience in the current Treasury Secretary and FHFA Director. That’s unfortunate, and it puts some obstacles in the path of whatever Treasury Secretary-designate Bessent and a new (still to be named) FHFA Director will want to do, but Yellen and Thompson’s exchange of letters and side letter don’t bind them in any way.
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Tim
I agree with you that “Yellen and Thompson’s exchange of letters and side letter don’t bind them in any way”, but disagree that “it puts some obstacles in the path of whatever Treasury Secretary-designate Bessent and a new (still to be named) FHFA Director will want to do”.
There will be obstacles only if Bessent and the new FHFA director exalt optics and appearances over substance and reality, like lifetime DC operatives Thompson and Yellen. But Bessent is not cut from that inbred Beltway cloth, and one hopes the new FHFA director will not be likewise.
In my view, the only real obstacle would be if Congress decides to hold hearings and get involved, motivated by Financial Establishment lobbying and contribution money. Here’s to hoping a very full Congressional schedule of to-dos that dont include the GSEs.
Happy New Year all!
ROLG
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Tim,
I do not understand how the new agreements between FHFA and TSY can be impediments to the incoming FHFA and TSY directors when the agreements have all along been between these same two agencies and rewritten each time to suit their then current political and economic goals. Why wouldn’t Bessent and Pulte, if confirmed, just follow suit and do the same, i.e., rewrite the agreements to suit the policies and interests of the Trump administration. Certainly, they will have the same powers as previous administrations but with improved company capital positions and mostly better recognition of what has transpired over the course of this conservatorship.
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Bessent and Pulte CAN rewrite the Yellen-Thompson agreements, as I said in my initial reaction to the January 2 letters (and side letter). But I could and should have been clearer on what I meant by saying that the intent of the letters was to put “obstacles in the path” of whatever Bessent and Pulte may wish to do.
As I noted in my post, Yellen and Thompson “showed no interest in addressing Fannie and Freddie’s conservatorships” during their entire tenures in the Biden administration, yet in their final month they felt compelled to send up flares warning of the dangers of any attempts by economic officials in the Trump administration to do so. This was a deliberate and aggressive clarion call to opponents of releasing the companies to make their objections to release known, and it included a proposed new set of bureaucratic processes—including solicitation of public comments and completion of a “market impact assessment”—that opponents of release can use to legitimize and as cover for the delaying tactics they almost certainly will try to employ to achieve the results they want. And as I said in my initial comment, I am puzzled as to why Biden’s Treasury Secretary and Director of FHFA felt the need to endorse the continuation of the status quo for Fannie and Freddie—since it is so harmful to the low- and moderate-income homebuyers the previous administration supposedly supported–and I am disappointed that they did.
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Director Thompson is leaving FHFA, as expected.
Additionally, Craig Phillips joined Freddie.
https://www.housingwire.com/articles/freddie-mac-hires-craig-phillips-to-handle-regulatory-and-conservatorship-affairs/
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Phillips was the first senior Treasury official I’m aware of to say that Fannie and Freddie had fully repaid their senior preferred stock.
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Tim, can you please go on Matt Levine’s podcast and tell him what’s what about the GSEs?
I read his column and heard his podcast and it’s frustrating how poorly it was framed.
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(I had to look up who Matt Levine is….)
Since before the conservatorships, the vast majority of the information about Fannie and Freddie in the media has been inaccurate. This started in 1999 with the formation and funding of FM Watch by three large banks, two mortgage insurers and a subprime lender, with a mission of “defining” Fannie and Freddie to the public as very risky companies with “unfair charter advantages,” who did little to lower the cost or increase the availability of mortgages—they just made money for themselves. The inaccurate portrayals of Fannie and Freddie accelerated and became more extreme after the conservatorships, because it was imperative for what I call the Financial Establishment to deflect blame for the Financial Crisis from the unregulated private-label securitization process that it had created and promoted—and which blew up spectacularly in the fall of 2007—and instead place the blame on Fannie and Freddie. The data have always shown this “blame shifting” to be utterly unsupportable, but that hasn’t stopped the firehose of misinformation about the companies from flowing at full volume to this day, to the point where the vast majority of the general public thinks the false story is true.
I started my blog in 2016 with no expectation that I would be able to affect the public perception of Fannie and Freddie, but in the hope that by making available, and explaining, the facts about the companies, and getting my posts and commentaries in front of opinion leaders and policymakers with influence over the future of the mortgage finance system, that slowly and over time the quality of the informed consensus about Fannie and Freddie might improve. I think it has (and no, I’m not claiming credit for it). I believe that now, both the supporters of recapitalization and release of Fannie and Freddie and its opponents know what the facts about the companies are (although the opponents don’t, and won’t, admit them). But I don’t think that public opinion is going to make much if any difference as to what happens with this issue; that’s going to be determined by those in the administration and the industry in a position to affect the outcome.
For that reason, I’m not pushing to offer myself as an interviewee, or a guest on podcasts—although if someone requests that I do an interview or go on a podcast I likely would accept the offer, because doing that certainly won’t hurt. I don’t, though, hold out much hope that my shooting a squirt gun of fact at a firehose of fiction is going to have much of an impact on the public perception of Fannie and Freddie.
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Don Layton, Former Freddie CEO 2012-2019:
https://furmancenter.org/thestoop/entry/the-gses-and-the-incoming-trump-administration-part-1-of-2-answering-ten-key-questions-about-conservatorship-exit
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Layton writes his pieces from the perspective of someone who believes many (but not all) of the fictions about Fannie and Freddie embraced by the Financial Establishment, including that they did need to be rescued by Treasury and also still need further “reforms,” and this makes removing them from conservatorship both controversial and difficult. It is controversial—because of all of the companies’ critics and opponents raising self-serving but groundless objections to it—but it won’t be difficult, or risky, to do, if Treasury has the will and courage to take the lead on it. Hank Paulson put Fannie and Freddie into conservatorship for the wrong reasons (which Treasury and the Financial Establishment have been dissembling about ever since); Scott Bessent can bring them out for the right ones.
I do acknowledge Layton’s point that neither President-elect Trump nor any of his appointees to key economic positions in his administration have yet to give any indication of whether they are even thinking about ending Fannie and Freddie’s conservatorships, let alone how or when they might do so. But there also are no good reasons for not releasing them, given their extraordinary levels of profitability and minimal degree of credit risk (as evidenced by their Dodd-Frank stress tests since 2021). And investors in Fannie and Freddie’s common and junior preferred stock have teed this issue up, and I believe will continue to pursue it aggressively. Layton downplays investors’ arguments in his piece, but I think he’s wrong. Even though the Supreme Court ruled against investors on the net worth sweep (on what I view to have been a blatant misinterpretation of the law), the reality is that both the investment community AND Treasury know the facts: Paulson took the companies over because he didn’t want to have to rely on them as private entities when they were the “only game in town” for getting the country through the financial crisis, made his takeover look like a rescue by having FHFA put over $300 billion in non-cash expenses on their books to force them to take $187 billion in senior preferred stock they didn’t ask for, didn’t need, and weren’t allowed to repay, and then, when many of those expenses began to reverse, entered into the net worth sweep with FHFA to prevent those reversing expenses from becoming capital (with Treasury officials admitting this in documents produced in discovery for a case in the Court of Federal Claims). For some reason Layton wants to pretend he doesn’t know this, but that’s irrelevant, because Treasury and Fannie and Freddie’s investors do.
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Bill Ackman (@BIllAckman), a major shareholder of GSE common shares, will have a live presentation on X, Jan 16th at 9am EST .
https://x.com/i/broadcasts/1vOxwrjeZgbJB
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A thought experiment for you, Tim.
If Treasury were to cancel the warrants and convert its senior preferred shares into 79.9% of the GSEs’ common stock instead of writing off the seniors and exercising the warrants for the same 79.9%, would your specific concerns about a senior-to-common conversion still apply?
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I don’t think it’s meaningful to speculate on issues like this without context. I have consistently said that any discussion about what Treasury should or might do with Fannie and Freddie will depend on what its objectives are. In the past I’ve given my opinion on what I believe those objectives ought to be, but it will be Treasury’s call.
On the seniors and the warrants, what I’ve said is that IF one of Treasury’s goals is to maximize the value of its current claims on the companies (seniors, liquidation preference and warrants), then deeming the seniors to have been paid, canceling the liquidation preference and then exercising the warrants and ultimately selling the resulting shares is likely the best way to do that. Compared with this alternative, the one postulated above is both internally illogical–it cancels warrant shares that Fannie and Freddie already recognize in their fully diluted share counts, then requires them to turn around and repay their Treasury senior preferred twice–and arbitrary (there is no economic basis for converting the seniors into four times the number of shares the companies have outstanding without the warrants).
Yet one also might ask, well, what if Treasury doesn’t want to maximize the value of its current stake in the companies? Since Treasury granted the warrants to itself, and under false pretenses–pretending to be rescuing the companies when it wanted to have control over them as “the only game in town” (in Secretary Paulson’s phrase) after the private-label securities market melted down and banks pulled back on their mortgage lending during the financial crisis–shouldn’t Treasury just cancel the warrants? Of course it should, but if you ask me if I think it’s likely Treasury will do that, my answer (unfortunately for existing common shareholders, including myself) is “no.”
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I don’t understand the part about Fannie and Freddie “repay[ing] their Treasury senior preferred twice”. The second round of payment Treasury receives would come not from the companies but instead from outside investors who buy the stock, the same as would happen if Treasury writes off the seniors and exercises the warrants.
The arbitrariness part is exactly the point. If Treasury acquires 79.9% of the GSE common, whether through warrant exercise or senior pref conversion and with the same end result either way (warrants and seniors gone), why would outside investors (buyers of this common stock) care about the exact mechanics by which Treasury acquired those shares?
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If Treasury asks for value to be conveyed–through conversion to common– for seniors that already have been repaid (although Treasury refuses to consider net worth sweep remittances repayments), that’s asking for them to be repaid twice. And I don’t intend to say anything further on this topic.
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Tim,
As a mathematical exercise, I have been assuming published shares outstanding would be increased if warrants are exercised. Above you stated “warrant shares that Fannie and Freddie already recognize in their fully diluted share counts”. For clarity, what is the number of shares outstanding? What would be the share count if warrants are exercised?
I see on Fannie’s 2023 balance sheet, 1,308,762,922 shares issued and 1,158,087,567 shares outstanding. So would those numbers be unchanged if warrants are exercised?
Or would it be 1,308,762,922 * 1.7999 =2,343,336,092 shares issued?
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First of all, in their quarterly earnings press releases, each company discloses both its outstanding shares of previously issued common stock (on its balance sheet) and its “weighted average shares of common stock” (on its income statement). The latter include the number of shares of common that would be issued if all equity warrants and convertible debt or junior preferred stock eligible for exercise or conversion were to be exercised or converted at the current share price. At September 30, 2024, Fannie disclosed that it had 1,158,087,567 previously issued shares that were still outstanding, and 5.867 billion weighted-average common shares outstanding. For Freddie, the same figures were 650,059,553 and 3.324 billion, respectively. The relationship between these two numbers is different from what one would calculate in assuming the warrants were exercised (by dividing the current outstanding shares of common by 1-0.799, or 0.201) because of the convertible debt and junior preferred.
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So for Fannie Mae, if they execute the warrants, shares outstanding would be 5,761,629,687. Of those shares 1,158,087,567 would be owned by the interests today (or their successors), 4,603,542,119 would be owned by the government. So assuming earnings of $16b/yr and assuming JPS still get a dividend, at average 6%ish of $33b stated value is about $2b. That leaves about $14b attributable to Commons, and that would mean, EPS to commons of ~$2.43/share ish. From there, analysts then speculate about earnings growth prospects and assign a P/E they think makes sense to get a market price, right? If we assume a P/E of 10, then they are worth $24.30 post warrant dilution. PE of 15 would be $36.44. PE of 5 would be $12.15. P/E of 20 would be $48.60 (coming up with a wide range). Can you fact check my math?
Assuming a P/E of 15, the government would potentially get a value of $36.44*4,603,542,119 = $167.75b
Freddie Mac for rough figures at 75% of FNMA would add about $126b (actual math would need to be done per above).
That nets the government $294b ish, which seems like what Ackman is promoting. Is my math correct or am I missing any important things? When I first saw his $300b number, it made me do a double take, but seems reasonable if his assumptions on government treatment to release end up true.
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I don’t comment on people’s specific valuation projections (although I’ll note that Fannie has $19 billion in outstanding junior preferred stock, not $33 billion), but as I’ve said previously the key assumption in any valuation projection is the P/E ratio the market assigns to Fannie’s or Freddie’s earnings. Recently that P/E has moved sharply higher, as investor optimism about a potential release of the companies from conservatorship has risen. But even Friday’s weighted average closing share price of $5.18 is still only a multiple of 1.7 times the companies’ combined trailing annualized 2024 earnings per share. To get anywhere in the range of the numbers you’re postulating will require actual resolution of the conservatorships, and where within (or outside of) that range the P/E ultimately ends up will depend on how favorably the conservatorships get resolved, with the most important elements being the treatment of Treasury’s senior preferred and liquidation preference, and a revision to the egregiously excessive ERCF.
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Wonder if Tim could write an article on GSE to educate readers of National Mortgage News or other media.
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Do you have any comments on Bill Ackman’s X post?
https://x.com/billackman/status/1873818034428694837?s=61&t=i_yxR71ajvS0jABrQWLy6A
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Ackman’s estimate of ~$34 per share is in the ballpark of the intrinsic value in his 2014 presentation which hinged on the assumption that Treasury forgives the value of the Senior Preferred Shares and exercises the warrants. According to Mark Calabria’s book, the Treasury Department under Trump’s first term claimed that it could not legally forgive the Senior Preferred Shares. Tim, do you have an opinion on the legality? Seems to me that the Supreme Court has since given the government the green light to do whatever it wants.
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I don’t give recommendations for investments in Fannie or Freddie common or junior preferred stock, nor do I make predictions about the possible future values of these securities. Having said that, though, I’m glad to read that Ackman endorses the ideas that “the GSEs [should be] credited with the dividends and other distributions paid on the government senior preferred, which would have the effect of fully retiring the senior preferreds at their stated 10% coupon rate with an extra $25 billion profit,” and that “the GSEs’ capital ratio [be] set at 2.5% of guarantees outstanding, a level which would have enabled the GSEs to cover nearly seven times the their actual realized losses incurred during the Great Financial Crisis.” I obviously agree with those recommendations, and believe they are the keys to releasing and recapitalizing Fannie and Freddie in a manner that would enable them to return to their traditional roles of providing large amounts of affordable financing to low- and moderate income mortgage borrowers.
Re Mr. Holland’s question, as I’ve noted before Treasury Secretary Paulson could not legally put Fannie and Freddie into conservatorship—only FHFA could do that—but he did it anyway, relying on what in his book he termed “the awesome power of the government,” and he did it when the companies did not meet any of the twelve criteria in the Housing and Economic Recovery Act under which FHFA could have put them in conservatorahip. More to the point, Treasury would not be “forgiving” the senior preferred; it would be recognizing the realities that had it not made the senior preferred repayable only with its permission, and subsequently imposed the net worth sweep (which it did not consider to be a repayment), the companies would have paid off the senior preferred, with its 10 percent annual dividend, long ago. So, no, I don’t give any credence to the notion that it would be illegal for Treasury to cancel the senior preferred.
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Thank you for both your insight and comments.
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Thanks. Just catching up.
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Tim,
reading tea leaves, I found this WSJ article interesting, re Trump transition interested in reducing bank regulation/regulators (paywall disabled):
https://www.wsj.com/finance/regulation/trump-advisers-bank-regulations-fdic-efa761dc?st=fVx9ew&reflink=desktopwebshare_permalink
FHFA will of course be dealt with later in the transition timeline than the bank regulatory agencies, but this may portend for a view on the ERCF at FHFA that might be helpful. it would be perverse to relax bank regulation and keep ERCF as is.
ROLG
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In 2016 French Hill introduced legislation that directed Treasury to take steps to end conservatorships. I believe it would have been arduous but that was 8 1/2 years ago.
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In Project 2025, the Heritage Foundation also says that “Treasury…should work to end the conservatorships.” What matters for any of these exhortations, including Hill’s in 2016, are the details of their proposed execution. I don’t know what Hill’s were back then.
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Great piece Tim,
Now that French Hill will become the new Chairman of the Finanial Services Committee, do you have any insight on his position on the GSE’s and whether or not he’s sympathetic to a release that’s favorable to shareholders both common and preferreds?
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When I was with Fannie (now almost 20 years ago), French Hill was not a supporter of the company. He was one of the “free-market” conservatives who thought Fannie and Freddie shouldn’t exist, but since they did should be subject to as many burdens and restrictions as their opponents could put on them. I hope he’s mellowed since then, but if I had to make a guess it would be that he will not be in favor of the type of recapitalization and release I am proposing.
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Thanks Tim, by the way, I was looking for you on X. Do you have an account there? You would enlighten a lot of readers there.
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I got a Twitter account when I published my book, but I never used it, and don’t know if it carried over to “X.” I’ve never really considered doing short bursts of assertion aimed at people I don’t know; I prefer longer, reasoned pieces, written for people who know me.
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Tim,
The Prescribed Leverage Buffer Amount (PLBA) in the ERCF is set at 1.5%, but the total capital at the end of the day ranges from 4%-4.25% ish. Is there any other buffer that you would think should be eliminated to make the final rule actually below 2.5% or is the PLBA close enough for an interim condition? Listed are the other 3 buffers:
My take is that the stress capital buffer at least is tied to stress test results after it exceeds the 0.75%, so has some relevance, but why it has a minimum really just makes it keep money for countercyclical purposes. It makes the countercyclical buffer pointless and just an add on to the stress capital buffer. Stability capital buffer has nothing at all to do with stress and is just intended to shrink the GSEs altogether in my opinion. So should both the PLBS and Stability Capital Buffer be terminated in your opinion for the interim condition?
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Calabria put four buffers into his final ERCF, dated December 2020. The Prescribed Leverage Buffer Amount (PLBA) was his addition to the 2.5 percent minimum capital (or leverage) percentage of the 2018 rule, and it was set at 1.5 percent to bring the total required minimum capital percentage to his desired “bank-like” level of 4.0. Director Thompson’s September 2021 amendments to the ERCF increased the capital credit given to the companies’ (non-economic) credit-risk transfer securities in the risk-based component of the rule and, in conjunction with that, also changed the definition of the PLBA from 1.5 percent to “half the amount of the stability capital buffer.” The recommendation I make in the current post is to eliminate the PLBA entirely, reducing Fannie and Freddie’s statutory minimum to the 2.5 percent it was in HERA, and also in FHFA’s 2018 capital rule.
The stability capital buffer is one of three buffers Calabria included in the risk-based component of the ERCF, to help push its total required capital above his 4.0 percent minimum. The others were the stress capital buffer (set at 75 basis points of “adjusted total assets”) and a countercyclical capital buffer, which was initially set at zero and still is. None of them are justified–including the stress capital buffer, as I discuss in the post “Capital Fact and Fiction”–and in the current post I recommend eliminating all of them, and also the minimum risk-weights on low-risk mortgages. But probably an even better “quick fix” would be what I suggested in a response to a comment a couple of days ago: “for Treasury to convince FHFA to declare that the ERCF is irreparably flawed, and that until it can re re-done and re-proposed Fannie and Freddie’s 2.5 percent minimum capital requirement from the 2018 rule will be in effect as long as the companies’ annual Dodd-Frank stress tests result in a level of initial required capital of 1.5 percent or less.” That would be readily understandable, and simpler.
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Superb, Tim, simply superb!!!
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Thanks for the prompt response Tim re the CET1 capital. Only a $23.8 billion shortfall means we are really close organically. Very encouraging if Treasury and FHFA listen to your common sense analysis of how to do this. And I think they will.
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Still sharp as a tack I see. Great read Mr. Howard. Would be great if it turned out like you suggest after all the work you have done over the years.
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What effect will a line of credit from Treasury have? Will it show up in the equity on the Balance sheet?
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Not to my knowledge. A continuation of the current Treasury line of credit–which when the companies are released from conservatorship would be paid for (at a rate “mutually agreed by Purchaser [Fannie or Freddie] and Seller [Treasury], subject to their reasonable discretion and in consultation with the Chairman of the Federal Reserve”)–would be reflected in the companies’ income statements, but not on their balance sheets.
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Fantastic piece! Thank you. l hope quant people read it.
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Thank you.
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Thanks again for another sensible and intelligent article (based on truths, fairness and real economics), Tim. For the good of all stakeholders, we can only hope the right folks within the incoming admin read your thoughts and are smart enough (and non-political enough) to carry them out.
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I wondered if you were going to comment on recent developments. I’m glad you did! Thanks, Tim.
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Jeff–Back on October 11, I said in a comment on this site, “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.” This is that piece. And I thought putting it up after Thanksgiving but before mid-December was the best timing for it.
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[Edited for length and clarity.] Thank you for writing this piece. You’ve long been a voice in the wilderness on all matters GSE. This may be your most clearheaded and straightforward post in this lengthy saga. We’d all be better off (at least those of us not benefiting from the various riskless ‘risk-sharing’ schemes or unloading bad PLS loans on the GSEs over the years) if more people listened to, and acted on, your sane proposals.
While your solution seems both eminently fair and feasible, I’d be surprised to see Treasury voluntarily give up all its senior preferred stock just to make this deal happen. A recent Katy O’Donnell Politico piece expresses some of the obstacles your plan may encounter. Read: https://www.politico.com/newsletters/morning-money
Ed Demarco is marshaled to pour water (better than when he was carrying it, one supposes) on the notion that Treasury is likely to surrender its senior preferred. “In a world where we operate with huge government deficits, writing off $330 billion that’s owed just through the liquidation preference, you know, is a pretty big step.”
O’Donnell quotes Ritchie Torres (D-NY 15th Congressional Dist) as favoring leaving the GSEs “in the grip of conservatorship.” Other Dems, who might otherwise be sympathetic to your care to ensure any solution bolsters affordable housing goals, are cited (as unnamed sources) as being “leery of the idea” of releasing the GSEs.
I’m also curious about another issue the Politico piece raises that you didn’t mention—but that may bolster your ideas to get the GSEs out of conservatorship. O’Donnell writes, “Even if lawmakers manage to sort everything out in the next year, there’s another question hanging over the process — how would the Congressional Budget Office score it? A 2020 CBO report on releasing the companies pointed out that ‘the net financial cost of an asset sale incorporates the present value of the expected proceeds from the sale, the loss of future revenues from the asset, and changes in future spending that would have occurred if the asset had remained in federal ownership.’” In Michael Bright’s words, “I can’t see how it’s free money. It’s possible CBO scores a sale as positive because it removes future bailout risk,” he said. “But I don’t see how it could be valued at the amount of revenue a sale would raise, because the government is letting go of revenue.”
Yours is yet another wonderful piece. Here’s hoping (the right) people listen.
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@djone
There is CBO scoring, and there is cash tax-cut “pay fors”. 2025 is going to be the year that the 2017 tax cuts are extended, and congress will be looking for offsets to anticipated revenue loss. I think going from zero cash inflow to Treasury from GSEs in respect of the SPS in 2024 to the likely in excess of $100B proceeds of the Treasury’s monetization will be viewed attractively.
oh and another thing, Bessent ain’t no Mnuchin.
ROLG
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I saw Katy O’Donnell’s article in Politico, and wasn’t surprised by it. Ed DeMarco has been a virulent opponent of Fannie and Freddie since before he was the Director of FHFA (when he was at Treasury), and he was the one who was raising Fannie and Freddie’s guaranty fees by 10 basis points a year in order to reduce their market shares, triggering the stalling out of their growth in the mid-2010s (that I mention in this post). So of course he’s going to say that Treasury’s “$330 billion liquidation preference” (now $341 billion) is “owed” to it. But this contention ignores two key points. The first is that today Fannie and Freddie are worth far less than $330 billion, so this amount is not collectible. And as I say in this post (and in “An Easy Way Out”) the way for Treasury to get maximum value from its stakes in the companies is not to nationalize them, but to make the warrants it has for 79.9 percent of their common stock more valuable by making them more valuable. DeMarco is simply wrong in his analysis (and O’Donnell repeats it without comment). And the second flaw in his argument is that he ignores the dozens of documents produced in discovery in the Court of Federal Claims that prove that the net worth sweep was concocted (back in December 2011) precisely to confiscate the earnings that Treasury knew were about to come cascading onto Fannie and Freddie’s income statements as the majority of the $300 billion in non-cash expenses booked earlier reversed and became revenue, and DeMarco also pretends that he doesn’t know that a jury in Fairhome v. FHFA found that FHFA “wrongly amended” the PSPA when it imposed the sweep. Fannie and Freddie HAVE paid back, with a 10 percent dividend, the monies Treasury forced them to borrow. They just shouldn’t be expected to turn over all of their income to Treasury in perpetuity, particularly when Treasury doesn’t have clean hands in its imposition of the net worth sweep.
I would make the same point about the CBO score. I don’t know how CBO can “score” a liquidation preference “debt” that’s not collectible, nor why it would ignore the approach I outline in my post that WOULD result in significant revenues coming to the government (and reducing the deficit).
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Hi Tim,
That is a genius plan. I really like your idea at the end to remove the buffer to get the ERCF back below 2.5% required in HERA, but why do you believe that would not require reissuance of the rule? Do you see it as too minor like some of the tweaks Sandra did to encourage more CRT transactions? Can we also add in something to make CRTs only be done when economic for GSEs while we are at it?
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On the “quick fix” to the ERCF, “reissuance” wasn’t the best choice of words (I’ve changed that to say “a full re-working of the rule”). I do think that at some point the ERCF will need to be completely re-done, because it has so many unfixable features, including having the risk-based capital stress test not count guaranty fees on loans that do not prepay during the stress period to absorb credit losses. But in the interim, the quick fixes I suggest could be accomplished by a reissuance of the rule with limited changes that doesn’t take much time to accomplish.
And, yes, it also would be a good idea to change the (excessive) capital credits FHFA gives to non-economic CRT issues. Right now there are two reasons Fannie and Freddie issue CRTs–FHFA sets objectives for CRT issuance (irrespective of their economics) that affect executive compensation, and it also gives far too generous capital credit for doing so (CRTs that cost the companies money should result in the companies having to hold MORE capital, not less). The former can be eliminated administratively, but the latter would also need to be changed with a “quick fix.”
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Tim
Great Job!
I have been thinking what a recap/release scenario would look like where the new FHFA director would “suspend” the “excessive Calabrian ERCF” provisions, perhaps via a consent order as part of the other negotiations to the SPS agreement etc, as the GSEs begin to pursue the public offering path. I have given some thought as well to a DOGE approach, for the new FHFA director to simply say that the ERCF does not have statutory support under HERA, and it is placed into pause for eventual rescission (using the SCOTUS recent agency caselaw re “major questions” and “deference”).
Would the public equity markets be satisfied with a realistic capital structure put in place on a “temporary” basis, pending a re-issuance of the GSE capital rule, which presumably would require notice and comment under the APA if the DOGE approach is not used.
Both processes could proceed simultaneously I suppose, as they both would require calendar year 2025 (at a minimum) to accomplish if they started coterminously. It will be easier to raise capital if the final sensible GSE capital rule was in place by the time of the public offering.
ROLG
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ROLG–As you might imagine, there is only so much one can put in a piece like this and still keep it at a manageable length (and have it be readable). I made my main focus the “what” and the “why,” thinking that if the new administration can agree on those, it shouldn’t be that difficult for them to work out the “how.”
Since the election I have read many comments from “the usual suspects” telling us why releasing Fannie and Freddie can’t or shouldn’t be done. But that’s because, for whatever reason they have, they don’t want it to be.
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Tim
In my view, the only reason why the new FHFA director may want to preserve the ERCF as is (subject to a consent decree that would require the GSEs to build capital to the ERCF targets as they are released and recapitalized) is to fend off officious intermeddling by Congress into the process, from the likes of Sen. Warner.
And that would be weak reasoning. The best course of action is to do the right thing, permit the GSEs to operate under realistic capital constraints that are well in excess of what Dodd/Frank stress tests would indicate, and then let the usual Senators bloviate for 5 hearing committee minutes. Let the Senators have their theater while the real professionals do the real work.
We shall see if Trump nominates as FHFA Director what I would call a “bank capital nerd”, or a housing professional. That would be a tell.
ROLG
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Another excellent article based on facts. If they in fact revisit the ERCF, do you think this has to be done before any agreement on how to treat the SPS? or can it be done after or in parallel?
I thought that the capital rule “revision” would have to come first. That way, Treasury has a better idea of further capital needed (to be raised) before they deem SPS repaid. This would also help them value the warrants and provide cover for a decision to deem SPS repaid (which will have some political blowback).
However, I admit I’m in “speculation land” on this one. I have my fingers crossed the GSE saga unfolds as you outlined above.
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I’ll start with a reminder that when the Housing and Economic Recovery Act (HERA) was signed into law on July 30, 2008, it specified twelve circumstances under which Fannie or Freddie could be placed into conservatorship. Neither company met any of them when Secretary Paulson decided he wanted to do it anyway, and in his book he said he relied on “the awesome power of the government” to get it done. No one challenged his action.
I’m not suggesting anything like that to get the companies OUT of conservatorship, but I will say that if Treasury really wants to do something quick with the ERCF there are many ways to get it done. One, which relies on the fact that the 2.5 percent minimum capital requirement for the companies was in both HERA and the 2018 Fannie and Freddie capital rule (pre-ERCF), would be for Treasury to convince FHFA to declare that the ERCF is irreparably flawed, and that until it can re re-done and re-proposed Fannie and Freddie’s 2.5 percent minimum capital requirement from the 2018 rule will be in effect as long as the companies’ annual Dodd-Frank stress tests result in a level of initial required capital of 1.5 percent or less. That should give the investment community enough certainty about the amount of capital required for them to reach full capitalization.
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Tim,
Your concise description of the interim capital requirements, 2.5% unless stress tests determine more than 1.5% is required, is unironically what a proper final ERCF rule should be. What you stated in one sentence takes our government years to study, months to draft a rule, more months to finalize it, and it ends up being novel in length after all of the lobbying and special interests get their way. Hopefully that changes.
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@Value Guy
as you suggest, any recap/release plan will require coordination among the GSEs, Treasury and FHFA. This coordination was absent in Trump 45, and we all should be looking for signs of its presence in Trump 47. for example, the GSEs can’t hire bankers and put together capital restoration plans leading to recap/release until they know what capital targets they must hit and when from FHFA, and what Treasury will do with its SPS. At some point, hopefully early on, a comprehensive plan emerges from among the participants.
as well, Trump needs to view the GSEs as unfinished business on his part, and needs to provide the participants in this saga some motivation. trump seems to me to be more assured of himself as POTUS going into 47 than he was going into 45, so we shall see if there is more assurance trickling down to FHFA and Treasury.
ROLG
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If at 2.5%, Fannie’s capital shortage is currently about $8B. Its net income is about $15B a year.
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No, that’s not accurate. At September 30, 2024 Fannie’s “adjusted total assets” were $4.446 trillion, and 2.5% of that is $111.15 billion. Were the Treasury senior preferred to be canceled, the company’s regulatory capital would be equal to its published net worth–$90.53 billion–less the amount of its $10.97 billion in deferred tax assets that exceed ten percent of its $71.40 billion in CET1 capital ($3.83 billion), or $86.7 billion. At September 30, 2024, required capital of $111.15 billion less actual regulatory capital of $86.7 billion results in a capital shortfall of $24.45 billion.
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Thanks Tim – Great article. I was looking at the 10-K and see where and how most of the above numbers came from but had a question of how you came up with the $71.40 in CET1 capital – could you please explain?
Thanks Tim!
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Jimm– Good catch; I did that math too quickly. (What’s confusing about the CET1 calculation is that the deduction you have to make under the ERCF to subtract a portion of deferred tax assets, or DTAs, isn’t from common equity, it’s from the CET1 number you haven’t calculated yet…)
Let me try it a different way. At September 30, 2024, Fannie’s adjusted total capital deficit was a negative $41.3 billion. That initially will go up to positive adjusted total capital of $79.5 billion when Fannie’s $120.8 billion in senior preferred stock is canceled (causing that amount–which is not included in the regulatory capital calculation–to be transferred to the “common equity” component, which is, raising it from a negative $49.4 to a positive $71.4). And this higher amount of common equity will result in a lower deduction from capital for Fannie’s DTAs. I had to iterate to get to what that deduction would be, and got about $3.1 billion, which is $7.9 billion less that the $11 billion deduction currently. That would make the new CET1 capital number $68.3 billion, and, adding back Fannie’s $19.1 billion in junior preferred, bring its adjusted capital to $87.4 billion, and making its deficit to 2.5% required capital $23.8 billion, slightly less than I had before. I think that’s right (and if it’s not, don’t tell me!)
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Thank you Tim for a sensible solution and path forward for releasing FnF from years of conservatorship.
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Thank you very much for the update, and the welcome positive news. Please consider cross posting on X!
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