jtimothyhoward - DECEMBER 17, 2021 AT 2:27 PM
I’ve now been able to read FHFA’s notice of proposed rule making on “Capital Planning and Stress Capital Buffer Determination.” My reaction is that it is a bureaucratic exercise in process that is bizarrely detached from the reality of the dire circumstances Fannie and Freddie currently find themselves in—for which FHFA itself (along with Treasury) bears direct responsibility.
Large commercial banks are highly complex entities, with multiple asset types in multiple currencies around the world, whose loss rates cannot easily be estimated.
Fannie and Freddie deal in one US-dollar asset type—residential mortgages—with two variants, single- and multifamily, whose loss rates ARE predictable.
FHFA doesn’t need a bank-like capital plan to understand what Fannie and Freddie’s capital problem is, and solving it is much more up to FHFA (and Treasury) than it is to the companies.
FHFA KNOWS the circumstances.
Take Fannie. As of September 30, 2021, its core, or Tier 1 capital was a negative $78.7 billion.
It’s that low because immediately after the conservatorship was imposed, FHFA booked $200 billion in temporary or estimated non-cash expenses to the company’s income statement, forcing it to take $116 billion in draws of Treasury senior preferred stock it didn’t need.
Treasury would not let Fannie repay this stock when the very large majority of these book expenses reversed and became income; instead, it, along with FHFA, imposed the net worth sweep and took those earnings (that would have become Fannie capital) for itself.
Next, former FHFA Director Mark Calabria imposed a ridiculously and unjustifiably high capital requirement on Fannie that bore no relationship to the risk of the loans it was guaranteeing.
The most recent risk-based capital requirement we’ve been given for the company by FHFA was for June 30, 2020, when it was 4.41 percent of adjusted total assets.
Updated for Fannie’s asset size today, that would require it to hold an estimated $191.4 billion in core capital—some $270.1 billion more that it now has.
Again, FHFA knows this, without Fannie having to file a capital plan.
So, what should Fannie’s capital plan say it should do?
Try to raise some of that in the market?
Well, that might be possible if FHFA and Treasury still weren’t insisting on keeping the net worth sweep in effect, and only suspending it temporarily to let Fannie add slowly to its core capital through retained earnings (while adding an amount equal to these increased retained earnings to Treasury’s liquidation preference).
What investor would buy common shares in the company under those circumstances?
So, the only real alternative Fannie has is to retain earnings indefinitely until either two decades (or more) have passed and it finally closes its capital gap, or FHFA wakes up and realizes that it and Treasury must cancel the net worth sweep, and it must re-do the capital standard to where it aligns with the readily quantifiable risk of the company’s one business, and the companies can then go to the equity market with a chance to obtain the additional common and preferred shares they need.
There is, however, a regulatory possibility that can’t be dismissed,
and it’s hinted at on page 7 of the proposal, which says that FHFA “may require an Enterprise to…restrict asset growth or activities, and take other appropriate actions to remediate the violation of the law”
(i.e., falling short of its statutory capital requirement).
If FHFA were to leave the sweep in place and not amend the capital standard to remove its layers upon layers of conservatism, then tell Fannie that it has, say, five years to meet its capital requirement, that would force shrinkage of its business, and by a massive amount.
Part of me hopes FHFA actually does that, because it would focus wide attention on how ridiculous and indefensible the agency’s policies towards Fannie and Freddie have been, and perhaps finally be the catalyst for sensible change to those policies that we’ve been waiting to see for eighteen years.
