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Freaky Friday

August 22, 2012

It must have seemed like “Freaky Friday” to the Treasury Department last week after it announced that the government is replacing the 10 percent quarterly compounding dividend it’s been charging Fannie Mae and Freddie Mac with a sweep of all of Fannie Mae’s and Freddie Mac’s profits. Republican congressional leaders attacked the move, the conservative commentator Peter Wallison lauded it, and Democratic congressional leaders ignored it.

It’s not every day that the US Government effectively takes over private companies.  The Administration actually has worked very hard to avoid it in the case of auto companies and other failed financial services companies that got bailed out.  But Fannie and Freddie are now working 24/7 for the American taxpayer.  And the change greatly reduces the likelihood that they will need further capital infusions to cover their guarantees, further protecting taxpayers.  

Think of this as the part in the gangland movie when the loan shark informs the hapless borrower that they’ve run out of time to repay and the Mob is now taking over their business. 

You’d think that those who have been the fiercest critics of the GSEs and the rescue of their MBS investors through Treasury capital infusions would be ecstatic.  No more capital infusions.  All profits flowing to the taxpayer.  No qualification that the sweeps will end when the total principal already invested is paid off.  Plus a clear statement that the Administration is committed to winding down the companies and an acceleration of the mandated run-off of their portfolios.

But that’s not how it worked out on Freaky Friday.

Instead, Republican congressional leaders attacked the decision.

“The reduction of the dividend payments for Fannie Mae and Freddie Mac will ensure the American taxpayers remain on the hook for the bailout of these two failed institutions for the foreseeable future,” said Rep. Scott Garrett (R-NJ) in a press release. The chairman of the Capital Markets Subcommittee of the House Financial Services Committee continued, “The crony-capitalism that has become a centerpiece of the Administration’s failed economic policy must come to an end.”    His colleague Rep. Spencer Bachus (R-AL), Chairman of the full House committee, added in his own release that “Eliminating the dividend that is owed to taxpayers irresponsibly benefits speculators and pre-conservatorship GSE stockholders at the expense of the American public.” 

 “Crony capitalism?”  The only cronies this move benefits are taxpayers, for whom the two companies are now working full time.  “…benefits speculators and preconservatorship GSE stockholders…?”  The Administration’s move actually finishes off any hopes speculators might still have had.  Common shares of the companies remain around $0.25, about where they were before the announcement and down from around $80 per share in 2004.  Their perpetual preferred stock, privately held mostly by speculators hoping the companies would eventually be rebooted as private entities, fell 55 percent on the announcement.  The companies are dead meat for investors until a “final solution” is crafted.  Even then, the Administration has made it clear that Fannie and Freddie as they existed before the financial meltdown are dead and gone.

Garrett’s and Bachus’ central complaint, that the Administration has not offered a comprehensive exit strategy and new mortgage finance system design, can’t be denied.  The Administration said as much themselves calling the change an interim step on the road to a full decommissioning of the companies.  Although these members are in the House majority, Republicans there also have failed to produce any legislation at the full Committee level to move past the current situation. 

Meanwhile, over at the American Enterprise Institute (AEI), the deep well of conservative thought and anti-GSE advocacy from which House Republicans usually drink heartily, senior scholar Peter Wallison was singing a different tune.  In an interview with BloombergBusinessWeek.com, Wallison said,

“The most significant issue here is whether Fannie and Freddie will come back to life because their profits will enable them to re-capitalize themselves and then it will look as though it is feasible for them to return as private companies backed by the government. What the Treasury Department seems to be doing here, and I think it’s a really good idea, is to deprive them of all their capital so that doesn’t happen.”

Meanwhile, House and Senate Democrats, and Senate Republican leaders on the Banking Committee have been shrouded in radio silence.  I searched their websites and Google News for quotes or reactions and found none.  Even the normally irrepressible Sen. Chuck Schumer (D-NY) took a pass on the issue. 

Freaky Friday, indeed.

Market Response

The biggest driver of the Treasury’s changed policy was the looming cap on new capital infusions that takes effect at the end of this year.  Market fears that this cap might erode the effective government guarantee behind GSE mortgage backed securities had widened spreads between GSE bonds and Ginnie Mae bonds.  The latter carry an unambiguous full faith and credit guarantee.  The Treasury strategy seems to have worked, at least initially.  BloombergBusinessWeek.com reported on August 17 that spreads had narrowed, albeit by only a small amount, in the immediate wake of the announcement.  An analyst quoted in the article speculated that some buyers who have been wary of the GSE bonds because of the potential cap on Treasury support would be more likely to return after the announcement.

Fannie and Freddie’s Big Loan Mod

August 17, 2012

The Administration today gave Fannie Mae and Freddie Mac a major loan modification and moved a step closer to their de facto nationalization by eliminating the quarterly compounding dividend payment they have been paying and replacing it with a sweep of any operating profits generated by the companies after paying for operations and reserves.   While these moves fall far short of the comprehensive plan for the mortgage system’s future promised in the Administration’s 2011 White Paper, they reinforce an emergent bipartisan Congressional and stakeholder consensus on the need for a continuing future federal role in assuring a stable and consumer-friendly mortgage finance system. 

In 2008, Treasury rescued Fannie and Freddie from insolvency and provided fresh capital to the companies by purchasing senior preferred stock, initially $100 billion each.  Existing common stockholders and other preferred stockholders were essentially wiped out, and the infusions enabled the companies to continue to intermediate capital investments in housing.  Good thing, too – as private investors fled the mortgage market, Fannie and Freddie’s share of mortgage financings grew to record-high levels, along with FHA and its securities gurantor Ginnie Mae.  Together these entities now provide nearly all capital used for refinances and home purchases.

As time went on and the companies’ distress from failed loans in securities they had guaranteed deepened, Treasury increased its infusions, ultimately committing to unlimited support through 2012, when the commitment would be capped at outstanding commitments made in 2010-2012, plus a maximum additional amount of $200 billion each.

The government’s help didn’t come cheap – both companies were required to pay quarterly compounding dividends of 10 percent on the capital advances, or twice as much as bank recipients of TARP funding paid.  Since Treasury’s investments began, the companies have paid out $45.7 billion in dividends on a total of $188 billion in Treasury capital infusions.  And because these payments were required every quarter, both companies repeatedly have had to seek additional Treasury assistance, primarily to pay the dividends, turning the Treasury agreements into perhaps the biggest, baddest payday loan ever.

Working with the companies and their conservator, the Federal Housing Finance Agency, Treasury has now amended these agreements.  The required quarterly dividends have been converted to a claim on all profits generated by the companies after paying for operations and maintaining a capital reserve fund.  Rather than continuing to accrue a compounding repayment obligation, the agreement caps the repayments to this amount.  Whether the commitment would end should the companies manage to pay back in full the amounts already advanced by Treasury is unclear; the amended agreements run through 2017.  But Treasury’s announcement states that the GSEs “…will be wound down and will not be allowed to retain profits, rebuild capital, and return to the market in their prior form,” and given the large amounts already advanced such a full repayment seems unlikely for the foreseeable future.”

Reassuring the Market

This shift from dividend to profit sweep converts Fannie and Freddie’s repayments from an above the line expense to a below the line expense.  This means that while the companies still have to repay the Treasury and taxpayers for their support, they will do so out only if their operating income exceeds their costs.  Under the agreements released today, no dividend obligation will be collected or, more importantly, accrue in any quarter where the companies do not meet this test.  Given that both Fannie and Freddie reported sufficient net income in the last quarter to fully repay the dividend and fund all their operations without needing additional Treasury support, the conversion greatly reduces the likelihood that any further infusions will be necessary.  

The change also should ease investors’ concerns over the capping of Treasury commitments that takes effect at the end of this year.  While the dividend payments were an above the line expense, they posed a constant drag on earnings and a threat that more Treasury capital would be needed to pay for them.  With contributions capped, investors feared that the day might come when the government’s backing for the companies effectively ended, throwing the value of their securities guarantee into doubt.  This anxiety is part of why investors have bid up the price of Ginnie Mae securities and bid down GSE bonds recently.  Today’s announcement likely will eliminate that concern.  Higher bids for GSE bonds would be direct evidence of that.  This should also mean lower mortgage costs for borrowers using conventional, rather than FHA, loans, since the bonds’ yields should rise.

Treasury also announced some other changes in GSE oversight today.

• Fannie and Freddie will be required to submit an annual report to Treasury “…on its actions to reduce taxpayer exposure to mortgage credit risk for both its guarantee book of business and retained investment portfolio.”
• The companies will accelerate the wind down of their mortgage portfolios from the current 10 percent per year to 15 percent per year, and reach a stabilized level of $250 billion each four years earlier than under the previous plan.

Who’s Your Daddy?

These changes mark a subtle but important shift in the government’s relationship with the GSEs.  The original investment model made Treasury and the taxpayers “super investors” in the companies.  They provided capital for entities still operating in theory as independent but heavily supervised private companies.  This left open the possibility, however remote, that the companies might someday be able to claw their way out of their hole, buy back the senior preferred stock and emerge intact from conservatorship. 

Now Treasury has made it clear that they basically own the companies and will collect every dollar of retained or excess earnings they produce.  When combined with FHFA’s own Strategic Plan for the companies’ future, the change moves the government closer to a path through which Fannie and Freddie are reengineered into a government owned operation of some kind to carry out the important utility functions needed to support a liquid mortgage securities market.

Foreclosed homes - What to Do?

April 06, 2012

With millions of families displaced by foreclosure, and their homes often sitting vacant and vandalized while the torturous process of foreclosure grinds on, new ideas have emerged about how to make better use of this inventory, especially to provide afforable rental housing while preserving the homes and preventing further deterioration of neighborhood values and conditions.  Literally billions of dollars in new investor equity has been marshalled in anticipation of bulk property sales that could provide bargain-priced homes that could be repurposed to rentals and eventual sale when markets improve.  Locally, “mom and pop” investors are bidding for these homes, and new would-be property owners/investors are showing up on courthouse stairs to bid for these properties.

At the federal level, the Federal Housing Finance Agency (FHFA) is pushing Fannie Mae and Freddie Mac to experiment selling some of their REO in bulk to investors who would convert the properties to rentals.  

Bank of America recently announced its own “Lease for Deed” pilot to allow curernt delinquent homeowners to swap their ownership for a long-term lease.  The program could lead to these families having the opportunity in the future to buy back the homes, as well.  If the pilot shows promise, BofA says they will expand it.

I was recently a guest on KCRW’s To the Point broadcast, which you can listen to here.

Refis for Underwater Borrowers

February 10, 2012

WSAV4 TV in Savannah, GA interviewed me there while I was attending a Mercy Housing, Inc. board meeting on February 1, 2012, the day that President Obama announced the Administration's proposal to have FHA help underwater borrowers refinance their loans.

A New Consensus?

September 11, 2011

As Washington has sweltered under a record heat wave this spring and summer, another thaw of sorts has been taking place on Capitol Hill. After two years of intensely partisan and polarizing positioning around the future of Fannie Mae and Freddie Mac, two bi-partisan proposals have created a new front that could signal a more hopeful future for the debate.

The two bills are HR 2143 sponsored by California Republican Gary Miller and New York Democrat Carolyn McCarthy and HR 1859 sponsored by California Republican John Campbell and Michigan Democrat Gary Peters are very different in key respects.

While the bills take radically different paths to a new market paradigm, both start from the premise that the federal government should continue to play a key role in the nation's mortgage system. Both bills would authorize government support for mortgage securities. Both would create new entities to succeed the failed mortgage giants Fannie Mae and Freddie Mac. And both would charge a new fee to cover the cost of an explicit and limited guarantee of mortgage securities - not entities that issue them. These common elements establish a new anchor for the debates to come in the House and Senate over the future of the mortgage finance system.

Until now, the only comprehensive Republican-backed proposal for a post-GSE world has been Rep. Jeb Hensarling's HR 1182, which would wind down Fannie and Freddie and leave no enduring federal role in the conventional mortgage market. Other Republican members of the House Financial Services Committee have introduced a flurry of bills that each attacks a different aspect of the GSEs' conservatorship and collectively endorse a much more constrained federal role. Rep. Scott Garrett's Capital Markets subcommittee has held hearings and mark-ups of these bills, but the full Committee has yet to schedule time to consider them. Hensarling's bill, and the adamant opposition to any continuing federal support for mortgage finance that it symbolizes, has support from Republican freshman back benchers, and surely will claim vocal support once the full Committee begins considering options.

The Miller-McCarthy bill would establish a publicly owned and operated "credit facility" for securitizing loans for both ownership and rental housing. The entity would absorb the current operations of Fannie Mae and Freddie Mac; those companies would be wound down through the current conservatorship. The new facility would maintain a portfolio, principally for enabling the facility to be a countercyclical force in the market, to modify delinquent and defaulted loans it has guaranteed, and to carry out specialized multifamily rental housing finance. The new facility would be governed by an independent board, and regulated by the current GSE regulator, the Federal Housing Finance Agency (FHFA). Although owned and operated by the US government, the facility's workers would neither be government employees, nor subject to its normal workplace and compensation rules. The facility would charge two separate fees for its securities - one to provide a top level guarantee, much like Fannie and Freddie historically have done, and a second to finance a new insurance fund to provide a catastrophic back-up guarantee. As with Fannie and Freddie, loans with less than 20 percent borrower equity would have to have further credit support, either through private mortgage insurance or participation by the originating lender.

The Campbell-Peters bill would authorize the establishment of new, chartered mortgage guarantors backed by private capital to guarantee securities for both rental and ownership. These entities could be owned by any financial services entity, including through lender cooperatives. While the new entities could operate portfolios, they would do so without any federal support. Their securities, meanwhile, would enjoy a catastrophic guarantee that would be financed through a fee paid by consumers. While this guarantee would protect investors in the mortgage backed securities issued by the new entities in the event their own capital is exhausted by losses, it would extend no protection to the investors or bondholders of the new entities. The entities would be chartered and regulated by the FHFA, and like Miller-McCarthy, would require additional credit support for loans with less than 20 percent borrower equity.

Common Ground

The sponsors' common embrace of a federal role in supporting the housing finance market is important because much of the debate around mortgage finance reform has hinged exactly on this point. Free-marketeers and conservatives generally have argued against any continuing federal role in the markets outside of FHA. According to these advocates, government involvement in the housing market was a leading cause of the mortgage crisis. In this narrative, increasing levels of directly and implicitly subsidized federal involvement in the housing markets since the Great Depression led to the catastrophic run up in housing prices in the 2000's, the rise of subprime lending, inflated house prices and the credit bust of 2007-08. They argue that only when the private market is allowed to operate without government involvement will markets stabilize.

The other side of this polarized debate has argued that market and regulatory failures in the early 2000's led to an explosion of private label mortgage securities fueled by an unregulated "originate to sell" underwriting model that fueled a race to the bottom in standards as originators, lenders, securitizers and investors sought ever greater volumes of supposedly safe and high-yielding mortgage securities. In this model, Fannie's and Freddie's market dominance - and the underwriting standards that had long dominated the market - were outrun by the private securities market. Their singular focus on residential mortgages and their very thin capital requirements put them in extreme jeopardy when the market collapsed, and their peculiar private ownership model led them to try to follow the stampeding herd into riskier loans in order to regain market share lost to private label securities, leading to catastrophic losses and government takeover. This narrative concludes that while the private ownership/implicit federal guarantee model of the GSEs is not sustainable any longer, a more constrained and focused federal role remains critical to ensuring liquidity, stability, and access to affordable and sustainable mortgage credit.

It looked like the debate over housing finance reform would turn into a straight-up death match between these views. But the introduction of these two bills has changed that dynamic. Neither bill is ready for prime time; they are both more like conceptual sketches than working blueprints. Progressives will find fault with both of these proposals - neither makes a significant effort to assure these new entities serve all communities and households, avoid "creaming" the markets, or extend credit to otherwise underserved areas. Conservatives will oppose the bills' fundamental embrace of a federal role. But that agreement in the bills to a fundamental support for a government role and the use of an explicit federal guarantee that is priced and paid for means that the debate's center of gravity has shifted significantly away from the bipolar extremes of only a few months ago.

There is little prospect of either of these bills moving forward any time in the near future. And it's likely that a significant portion of senior committee leaders and restive back benchers will continue to push for the elimination of federal support in mortgage markets.

But Miller, McCarthy, Campbell and Peters have vowed to press for hearings on their bills, and to bring them up whenever GSE reform is discussed in the House Financial Services Committee. The fact that Republicans and Democrats are beginning to talk about the same fundamental premises and are collaborating together to design a new approach based on them is notable in its own right as a bright spot in an otherwise polarized landscape. It gives the Administration more room to maneuver as it readies Version 2.0 of its own proposals. It will shift the debate's middle ground further to the left than seemed likely only a few months ago.