TH: "I did not have a positive reaction to the Layton piece.
I almost stopped reading it when he wrote, “Before conservatorship, [the average guaranty fee] was set by the GSEs themselves at a low level as much for political reasons (in particular to help maintain their lobbying power in Congress…) as economic ones.” That’s utter rubbish. Layton wasn’t at Freddie during the period he was referring to, while I was responsible for setting Fannie’s target guaranty fees through 2004. They were determined by highly sophisticated pricing models that were purely economic. (I discuss a bit of this in my August 2022 post, “Mind the Gap.”) And it gets worse, when he gets into a screed about their portfolio businesses and the “implied guarantee” on their debt, claiming that they “exploit[ed] this free implied guarantee to create a giant, profit-making subsidy for themselves… [that] disproportionately benefitted their management and shareholders rather than homeowners.”
What’s the point of saying this? First, it’s counterproductive to a quick and clean exit from conservatorship, because it reinforces the “flawed business model” notion pushed by the banks. Second, what Layton is claiming about the “retained subsidy” of the portfolio business is taken straight from the talking points of FM Watch in the early 2000s, and is completely made up. Yes, Fannie and Freddie’s debt benefited from an “implied government guaranty” that lowered their cost of borrowing. But that was a deliberate feature of their charters. And a second feature of those charters was they could only use their debt to buy mortgages and MBS whose yields (or prices) ALSO benefited from that same guaranty. There is no way to “retain” a subsidy that’s attached both to the debt you’re issuing and the only asset you’re allowed to buy. No, the role Fannie and Freddie’s portfolios played was to keep the spreads between the rates on mortgages and MBS from getting too high relative to fixed-term debt. Whenever that happened, Fannie and Freddie would issue (relatively cheap) debt, and use the proceeds to buy (relatively expensive) mortgages and MBS, thus keeping spreads in line. That’s economics, not politics, and it was beneficial to homebuyers. The banks didn’t like it because it held down THEIR portfolio spreads, and that’s why they invented the story Layton is parroting here.
To have to read this nonsense from Layton at a time the public is learning that the Federal Reserve has been short-funding its now $2.6 trillion portfolio of agency MBS since its inception in 2009–and is on track to lose over $100 billion this year from doing s0–and also learning about unregulated and unsupervised banks “playing the yield curve” because their Basel III capital standards allow them to do so without penalty, is galling. But, yes, do take uninformed and mis-aimed shots at Fannie and Freddie to distract from what the banks and the Fed are doing.
As for the rest of the paper, it’s great that Layton doesn’t think Fannie and Freddie need to hold 4 percent capital to safely do a credit guaranty business that has a credit loss rate of 4 basis points a year on a normalized basis, and can withstand a stylized repeat of the Great Financial Crisis through absorbing all of the resultant credit losses with only its current guaranty fee income, and not have to touch its capital all. Virtually every other knowledgeable person who has objectively reviewed Fannie and Freddie’s business and the Calabria capital requirement has come to the same conclusion–and their opinions don’t come with all of the baggage Layton attaches to his."
AI
