Politics sometimes requires choosing the least bad option. That may be the best way to assess the Federal Housing Finance Agency’s (FHFA) eleventh-hour push to release government-sponsored enterprises
from their 12-year captivity.
In a better political world, the housing godzillas would have been unwound after the financial crisis. Recall Congress created the GSEs to guarantee mortgages with the purpose of increasing liquidity to the housing market. Their implicit government backstop allowed them to expand their footprints and leverage, which yielded enormous profits.
When the housing bubble burst, Fannie and Freddie were stuck with enormous losses on toxic mortgages. At that point they should have been placed in receivership. But the Bush Treasury opted for conservatorship under regulatory control by the FHFA.
With a $190 billion injection from Treasury, they gained a new lease on life. In return, Treasury received preferred senior stock, which the giants were supposed to pay a 10% dividend on liquidation preference, and warrants to acquire 79.9% of common shares. The GSEs were also supposed to pay a fee for the government’s open-ended credit.
Because they were unable to pay the required dividend or fee, Treasury in 2012 began sweeping their net earnings. Fan and Fred shareholders on Wall Street argue that the government has unfairly appropriated hundreds of billions of dollars in profits. But Treasury still hasn’t come close to being repaid what it was originally owed under the 2008 agreement for rescuing the giants.
The GSEs also owe their profits to their taxpayer backstop, which allows them to underprice competitors. Their business model is essentially to privatize profits and socialize risk. In good times, shareholders and executives make out like bandits while taxpayers pay for losses in the bad times.
Idaho Sen. Mike Crapo
Texas Rep. Jeb Hensarling
have tried to roll reform up Capitol Hill only to have it crash back down as soon as Fannie and Freddie mobilize their friends in the housing lobby.
All of this is context for negotiations now taking place between Treasury Secretary Steven Mnuchin and FHFA Director
to release the GSEs before they are sufficiently reformed or recapitalized. Mr. Calabria’s term ends in 2024, but the Supreme Court is hearing a case Wednesday about limits on the President’s ability to remove the FHFA head at will.
would likely replace Mr. Calabria with a more permissive overseer like Obama-appointed director
who lowered GSE underwriting standards while blessing a Fan and Fred end-run around statutory limits on executive compensation.
Hence, Treasury and FHFA are considering a consent order between the GSEs and FHFA that could end government conservatorship of Fannie and Freddie while binding both the Biden Administration and GSEs. Financial regulators often use such orders to compel reforms at undercapitalized or incompliant banks. Fan and Fred are both.
Mr. Calabria recently finalized a capital rule that would require the GSEs to hold a combined $283 billion cushion against losses. They now have a paltry $35 billion. The GSEs and housing lobby complain the rule is too onerous and will no doubt push the Biden team to weaken it.
A consent decree could hard-wire strict capital requirements so Biden appointees couldn’t water them down. It also could and should include limits on the GSE investment portfolios, guarantee activities (e.g., no cash-out refinances and vacation homes) and dividends. If the GSEs are to be released, they need to be kept on a tight leash.
Predictably, the GSEs, Wall Street investors and housing lobby are mobilizing their friends in Washington. The housing lobby would prefer to keep the GSEs enslaved to a Biden Administration so they can be used to juice housing. To increase their capital, Fannie and Freddie would have to raise the fees they charge for their loan guarantee, which could crimp profits for mortgage originators. Higher fees and restrictions could also take some wind out of the refinance boom. None of this will do much harm in a roaring housing market.
Meanwhile, Wall Street investors want the Trump Administration to release the godzillas without chains. It could take the GSEs a decade to retain enough capital to meet Mr. Calabria’s rule. Selling new shares could help them raise capital faster and pay dividends sooner, but restrictions on activities will limit the return on equity. Given their implicit government guarantee, this is hardly too much to ask.
Some Members of Congress argue that GSEs haven’t fully repaid taxpayers. Fair enough, and a consent order should require the GSEs to pay for their implicit government backstop and Treasury’s senior preferred shares over time. They shouldn’t be allowed to pay dividends until they do.
But the risk to taxpayers now of keeping Fannie and Freddie in government captivity probably outweighs that of releasing them with a ball and chain. A consent order, unfortunately, won’t last forever. But if Congress can’t muster the political will to end their guarantee, then Mr. Calabria’s plan is the least bad policy.
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