navycmdr Member Level Friday, 09/13/19 09:26:12 PM
Re: None 0
Post # of 559240
How Once-Doomed Mortgage Giants Gained New Lease on Life
Fannie Mae and Freddie Mac cranked out profits as housing recovered
after the financial crisis, and Congress couldn’t come up with a very good
alternative to them
Fannie Mae headquarters in Washington ANDREW HARRER/BLOOMBERG NEWS
By Andrew Ackerman and Nick Timiraos - Sept. 13, 2019 12:15 pm ET
For years after the 2008 mortgage-market meltdown, Republicans and Democrats agreed on little about what to do with Fannie Mae and Freddie Mac except one thing: Get rid of them.
A Trump administration housing-finance roadmap released last week would do the opposite, allowing the government-controlled companies to remain at the center of the American home-ownership system for years to come. Washington reluctantly recognized the difficulty of replacing institutions that undergird the home-buying market.
The administration’s report outlines a path that would return the firms to private ownership but with a government backstop. An envisioned multiyear transition won’t have any immediate effect on housing markets, but its impact in the future will turn on many details that remain to be decided.
How policy makers and the companies balance the competing demands of protecting taxpayers, delivering a return to the companies’ shareholders and ensuring access to home loans will help determine who gets mortgages and on what terms.
Treasury Secretary Steven Mnuchin taking questions after a Senate committee hearing on housing finance Sept. 10. PHOTO: ANDREW HARNIK/ASSOCIATED PRESS
Fannie and Freddie don’t make loans but buy them from lenders. They package them into securities that are sold to investors, and provide guarantees to make the investors whole if the loans default.
This enables lenders get their money back so they can lend again, by matching them up with investors such as pension and hedge funds that wouldn’t otherwise invest in home loans. This role has helped preserve America’s popular 30-year, fixed-rate mortgage—something few other countries have—including during savings-and-loan crises in the 1980s.
It also requires an unusual degree of government support. The setup relied on an implicit understanding in bond markets that the U.S. government would bail out Fannie and Freddie if they ever got into trouble, given the importance of their middleman role for the national economy.
Fannie Mae and Freddie Mac lost market share during the housing bubble but have since played a large role.
The arrangement led the government to step in and take over Fannie and Freddie at the start of the 2008 financial crisis as the publicly traded companies faced big losses.
They had gotten into trouble by taking on increasing risks, primarily to compete with Wall Street firms and later because lawmakers wanted them to support a weakening housing market.
They also speculated heavily in the very mortgage market they served, benefiting from a low cost of capital resulting from their implied federal guarantee.
As companies that also paid their executives richly, and that used their lobbying clout to block efforts to make them hold more capital, Fannie and Freddie, by the time of the financial crisis, had worn out their welcome in Washington.
Obama administration officials who took over in 2009 weren’t in sync on what to do with the so-called government-sponsored enterprises, or GSEs, but agreed they shouldn’t just be recapitalized and sent on their way.
At one meeting in 2010, a senior administration official sought to paper over disagreements by joking that they were united on a public message that could be summed up on a bumper sticker, according to two people present. The slogan: “F— the GSEs.”
The companies' crisis-era loans, while performing poorly, had lower default rates than mortgages pooledand issued as securities by Wall Street competitors.
At a later meeting, White House economist Austan Goolsbee compared them to comic-book villains captured and imprisoned in a cell on the ocean floor. It would be folly, he said, to turn the companies loose just because they had promised to behave.
The administration began calling on Congress to advance legislation to replace the mortgage buyers and guarantors. All of the ideas that seemed feasible turned out to have their own drawbacks. Many would have required steps to raise the cost of credit for homeowners.
Meantime, once housing markets rebounded, Fannie and Freddie played even bigger roles than before the crisis. They went from running big losses to racking up multibillion-dollar profits, which the Treasury Department collected through a fat dividend arranged at the time of their bailout.
The companies still had public shares, which many investors saw as nearly worthless, but which some distressed-asset specialists bet on. In 2012, the Obama administration replaced the fixed dividend from Fannie and Freddie with a new arrangement in which nearly all of the companies’ profits flow to the Treasury, damaging investors’ bets.
SHARE YOUR THOUGHTS
Should the U.S. stick with Fannie Mae and Freddie Mac or is there a better way to support the home-buying market? Join the conversation below?
With that move, and the housing market’s comeback, some in Washington began to defend the GSEs, especially after their payments to the government had far exceeded the cost of the 2008 bailout. Taking a page from Fannie and Freddie’s precrisis lobbying muscle, some investors began paying nonprofit groups and well-connected industry experts to argue the companies shouldn’t be dismantled.
They also sued, challenging as unconstitutional the government’s claim on nearly all Fannie and Freddie profits. For years, the courts ruled against these suits.
Some industry veterans long maintained the goal of replacing the mortgage companies wasn’t realistic. “The plumbing of the U.S. mortgage market runs through these companies,” said Daniel Mudd, Fannie’s chief executive from 2005 to 2008.
By the end of the Obama administration, the companies had made operational changes that limited U.S. taxpayers’ risks. Their regulator forced them to adopt tougher underwriting standards, shrink their investment portfolios and ramp up sales of new instruments by which private investors would absorb some loan losses. They also faced curbs on executive pay.
Large profits have replaced massive losses as a result of the housing market recovery.
Cumulative Treasury infusions to Fannie and Freddie and amounts paid back, in billions
Although Republicans had long led the campaign to abolish the companies, when Trump-campaign finance director Steven Mnuchin interviewed for the job of Treasury secretary, he included in this priority list an overhaul of Fannie and Freddie.
Mr. Mnuchin, as Treasury secretary, approached the issue not as a Washington insider steeped in battles of the 1990s and 2000s over the GSEs but as a capital-markets veteran. He had run the mortgage-trading desk at Goldman Sachs Group Inc. and later overseen the turnaround of a failed thrift, IndyMac Bank, renamed OneWest Bank.
Mr. Mnuchin invested in OneWest alongside John Paulson, a hedge-fund investor famed for profiting by shorting the subprime-mortgage market before its collapse, who later bet heavily on a revival of Fannie and Freddie. Mr. Paulson was also a top donor to the Trump campaign and counted both Mr. Trump and Mr. Mnuchin as investors in Mr. Paulson’s hedge funds in 2016, according to financial disclosures.
“Clearly, there has been value in having a Treasury secretary who has a deeper personal understanding of the housing-finance market than probably anybody else who has ever sat in his seat before,” said Timothy Mayopoulos, who was Fannie Mae’s chief executive for six years until last year.
“There has been a wholesale shift from blowing up the entire housing-finance system and starting from scratch to focusing on what should be preserved because it works, and fixing what doesn’t,” Mr. Mayopoulos said.
Then-candidate Donald Trump with investor John Paulson in September 2016. Mr. Trump invested in Mr. Paulson’s hedge funds, according to financial disclosures.
No policy maker embodies the shift more than Mark Calabria, a libertarian economist who long called for abolishing the mortgage-finance giants and rejected the idea of piecemeal changes to them.
Now, as the head of their regulator, the Federal Housing Finance Agency, Mr. Calabria will play a lead role implementing Treasury’s blueprint.
The debate over what to do with Fannie and Freddie has evolved into “What’s the public-policy problem that we’re trying to fix?” Mr. Calabria said. “I see that as a positive move.”
Newsletter Sign-up
The mortgage companies’ survival got another boost last week when a federal appellate court overturned a ruling that had supported the sweeping of their profits into the Treasury. The court didn’t invalidate the sweep, but its ruling suggested the judges were critical of it. The administration is deciding whether to appeal.
Messrs. Calabria and Mnuchin have asked lawmakers to act on a broad overhaul of housing finance. That is a tall order as the presidential election cycle gets under way, particularly after a decade of inaction by Congress. So Treasury and the FHFA are preparing to privatize the companies administratively.
“There is this problem that legislation in this area is hard, and without it, there aren’t great tools” to resolve the companies’ current status aside from recapitalizing and releasing them from government control, said Jacob Lew, Treasury secretary from 2013 to 2017 in the Obama administration.
The first step is to increase the amount of capital the mortgage companies must hold to absorb future losses, through a combination of retained earnings and new stock offerings over several years.
After that, the government could also exercise warrants letting them acquire nearly 80% of the firms’ common stock before selling the shares in a public offering.
Federal Housing Finance Agency Director Mark Calabria, right, with Housing and Urban Development Secretary Ben Carson,
The companies’ future activities could be limited as a condition for their continued reliance on a federal backstop. Under the Trump administration plan, they would pay a fee for that support.
Privatizing Fannie and Freddie would be complicated because of their perceived government guarantee. Critics worry that privatization could lead one day to the circumstances that brought on the original crisis, with the companies facing pressure from shareholders or the government to take on too many risks.
Policy makers could move to recapitalize the companies quickly by doing stock offerings and luring investors with dividends. But those dividends would eventually cut against the goal of having enough capital to protect taxpayers. Meantime, the pressure to keep housing costs low could tempt the government to charge too little for a federal guarantee.
“Republicans are standing up for shareholders. Democrats are standing up for customers, and nobody is standing up for the taxpayers’ liability,“ said Lawrence Summers, who was President Clinton’s Treasury secretary and an adviser to President Obama from 2009 to 2011.
”It’s a politically compelling formula. You staple very effectively the most popular constituency in America—homeowners—to the shareholders.”
The broad state of affairs “looks to me like ‘Back to the Future,’” said Mr. Summers, who in 1999 began raising concerns about the risks the companies could pose.
Customers lined up in July 2008 in front of a Santa Monica, Calif., branch of failed thrift IndyMac Bank. Steven Mnuchin, now Treasury secretary, helped turn it around under the new name OneWest Bank.
Mr. Mudd, the former Fannie CEO, said he remains skeptical of how well a company can serve two different masters: fulfilling a public mission of ensuring access to mortgages across all markets and at all times, while also satisfying private investors.
“There is one foot on the rolling log of public policy, and the other foot on the rolling log of running a commercial business that can raise its own capital,” he said. “There are times where those logs don’t stay very close together.”
—Kate Davidson contributed to this article.
AI
