Terry Wespestad - JULY 18, 2021 AT 5:21 PM
Tim, could you please elaborate on your comment about the Biden administration having an easy route out of conservatorship, if they have the will to do it.
jtimothyhoward - JULY 19, 2021 AT 11:44 AM
As you’ll note by re-reading my comment (above), I didn’t say an “easy” route; I said a “very simple” one. The two are not the same.
The “very simple thing” the Biden administration could do to get Fannie and Freddie out of conservatorship is essentially to reverse what the Bush administration (Treasury Secretary Paulson specifically) did to put them into it. You may know that Paulson forced them into conservatorship for policy reasons—I believe because he was unwilling to leave them as “the only game in town” (his words) after the private-label securities market collapsed, and banks had drastically cut back on their mortgage lending because of soaring delinquency rates (triple Fannie and Freddie’s), and that he also saw in the financial crisis an opportunity to get control of two companies Treasury historically had opposed.
Treasury’s intent was to replace them with an alternative more favored by the commercial banks, and to that end it had FHFA add over $300 billion in temporary or estimated non-cash expenses to the companies’ books, forcing them to take $187 billion in non-repayable senior preferred stock from Treasury, paying a 10 percent after-tax annual dividend.
Treasury (and the rest of what I call the Financial Establishment) then rewrote history to claim that Fannie and Freddie were the causes of the financial crisis, that the $187 billion was a real cost of their “rescue”
(in fact, this amount was repaid in just eighteen months), and that even today the companies are so risky that they can’t be released from conservatorship before they have 3 percent Tier 1 capital, on their way to a full requirement of about 4.5 percent in total capital (more for Fannie, less for Freddie).
Where we are today is that virtually everyone believes the fiction that Fannie and Freddie caused the financial crisis and are terribly risky, the Financial Establishment in thirteen years has been unable to come up with a workable way to replace them, and the Supreme Court has just said that it is perfectly legal for FHFA to give all of the companies’ net income to Treasury in perpetuity, making it impossible to for them to get out of conservatorship on their own for more than a decade, and even then leaving them where they have to grossly overprice their credit guarantees because of arbitrary capital requirements that bear no relationship to the risks of the mortgages whose credit they are guaranteeing.
So, what is the “simple thing” the Biden administration can do to fix this?
Say the Bush Treasury made a huge policy blunder in taking over, without statutory authority and by coercion, the two companies who were by far the healthiest providers of mortgage credit going into the crisis, then deliberately inflating their book losses to burden them with mammoth amounts of non-repayable senior preferred stock that has led them to remain in perpetual conservatorship. It would say that Fannie and Freddie have paid back all of the $187 billion (now a bit more) they had to draw during the crisis, with 10 percent interest, so that the Biden administration can deem the Treasury senior preferred stock repaid (while pointing out that no regulator anywhere in the world has ever used non-repayable senior preferred stock to “rescue” a company, or for any other purpose) and also cancel Treasury’s liquidation preference.
It then would appoint a new director of FHFA, and ask him or her to come up with a true risk-based capital standard for Fannie and Freddie (to replace Mark Calabria’s, which had ridiculous amounts of indefensible assumptions, cushions and conservatism to force the final percentage above the “bank-like” 4.0 percent minimum he insisted on imposing on the companies, irrespective of their risk) that would enable them to them price all of their business—but particularly their affordable housing loans—on an economic basis.
With Treasury’s senior preferred stock deemed repaid and its liquidation preference cancelled, settling the remaining lawsuits should not be difficult, and with a reasonable risk-based capital requirement (and a minimum tailored to that requirement, rather than the other way around), it should be possible to release Fannie and Freddie from conservatorship fairly quickly, to enable them to reach full capitalization through new issues of capital (which investors would eagerly buy if the companies are structured to succeed as private companies, rather than struggle per the Calabria standard).
I view that as simple. Coming up with the political will to do it is harder, but a good place to start would be for senior economic policy officials in the Biden administration to embrace the (readily available) facts about the companies’ past history and current risks, rather than the fictions spread by their critics, opponents and competitors over the past twenty-plus years.
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