Interesting take from TH today on Eternal Patience question on whether or not SVB fallout will end any likelihood of the end of the conservatorships relatively soon:
"...the Basel III bank capital standards–which former FHFA director Calabria insisted on imposing on Fannie and Freddie–have NO capital consequence at all for taking interest rate risk. The only way to keep banks from doing it is through stress testing, and enhanced supervision. But SVB and Signature were exempted from both.
As Yellen, Brainard, Rouse (and I’m sure Bernstein) know, interest rate risk at banks is now a BIG systemic problem. There is a chart from the FDIC showing up in the financial press that gives unrealized losses on investment securities at FDIC-insured institutions. Those losses rose from nothing at the end of 2021 to $700 billion on September 30, 2022, as short-term interest rates rose throughout the year. And that’s just the securities; it doesn’t include long-term fixed rate whole (i.e., unsecuritized) mortgages.
We don’t know how many banks did what SVB and Signature did–but the bank regulators (and the senior members of the Biden economic team) do. And very few banks hedge their interest risk. Nor does the Federal Reserve. As I noted in a comment yesterday; it was short-funding all of the $2.6 trillion in agency MBS it acquired since 2009, and while it made over $100 billion (turned over to Treasury) in 2021 when short-term interest rates were essentially zero, it started losing money on its securities portfolio last year after it began to hike the federal funds rate, and it’s on track to LOSE $100 billion this year. That gives you some idea of the problems the banking system might be facing.
How does all this relate to Fannie and Freddie? They’re in conservatorship–and grossly overcapitalized and over-regulated–because that’s what the banks wanted. Banks and their supporters used fictions about the companies’ operations and risks to convince policymakers (and, through a compliant media, the general public) that Fannie and Freddie needed at least 4 per cent capital to do their (very low-risk) credit guaranty business safely, and that they should remain in conservatorship until they accumulate that amount of capital through retained earnings, which likely will take another 20 years.
Banks have profited handsomely from the constraints imposed by Treasury and FHFA on Fannie and Freddie’s business since 2008. As I noted in my current post, “At December 31, 2007, banks held $2.29 trillion in single-family whole loans and MBS, or 23 percent of outstanding single-family mortgage debt, on their balance sheets. At June 30, 2022 (the latest date for which full data are available), banks held more than double that amount—$4.65 trillion, for a 36 percent market share.”
I’ve raised the issue numerous times of the systemic risk involved in shifting that large an amount of mortgages from contractual investors–mutual funds, pension funds and insurance companies, which can manage the interest rate and options risk of MBS–to commercial banks who can (or do) not. But that’s only been a theoretical concern, until last Friday.
I have little doubt that the Biden economic team now realizes that the credit risk-taking frenzy that nearly collapsed the world financial system in 2008 may have been replicated over the past several years of zero short-term interest rates by an interest rate risk-taking frenzy, led by commercial banks. And after they contain the damages from this risk (assuming that they do), does it not make perfect sense for them to then move to fix one of the main contributors to the interest rate risk-taking frenzy–having allowed the banks to cripple Fannie and Freddie by making false claims about their operations and risks, and tying them up in conservatorship for another 20 years, so that mortgages that otherwise would have been safely funded by contractual buyers of MBS instead go into short-funded bank portfolios?
Quite contrary to your reaction, then, I think the SVB and Signature bank failures, and the associated awareness of the risks that have been building up in the banking system over the past several years, make action on getting Fannie and Freddie out of conservatorship more likely during the remaining months of the president’s term, by raising the profile of the companies (and the roles they could be playing in mortgage finance), undermining the credibility of the Financial Establishment and the banks (who’ve been telling fictitious, and we now know dangerous, stories about Fannie and Freddie since the 2008 crisis), and giving the Biden economic team more incentive, and courage, to stand up to the leaders of the Financial Establishment and take them, and this issue, on."
