Nov 4, 2019,04:07pm EST|4,175 viewsForbes: The Government Should Have Shut Down Fannie and Freddie In 2008 – They Still CanNorbert Michel Contributor PolicyI follow the evolution and devolution of monetary and financial policyWASHINGTON, DC – SEPTEMBER 10: U.S. Treasury Secretary StevenMnuchin (L), U.S. Housing and Urban … [+] GETTY IMAGEShttps://www.forbes.com/sites/norbertmichel/
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1 Our nation’s housing finance system was at the center of the 2008 financialcrisis. Yet our elected officials have done nothing to fix the problem—untilnow. Credit Mark Calabria, the new director of the Federal Housing FinanceAgency (FHFA), for giving it an honest effort.2 Despite all the hype claiming that the Dodd-Frank Act would fix the financialsystem and make everyone safer, Fannie Mae and Freddie Mac are essentiallyjust as weak today – and just as dangerously leveraged – as they were in 2008.3 Calabria and his new team at the FHFA can’t be expected to solve thisproblem overnight, but it looks like they are on the right path.4 On the heels of reiterating that the federal government should have wipedout Fannie and Freddie’s shareholders in 2008, Calabria recently warnedmembers of the Mortgage Bankers Association that “Today’s status quo posessignificant risk to taxpayers, homeowners, renters, and the entire financialsystem.”5 Last week, the agency released its new Strategic Plan for theConservatorships of Fannie Mae And Freddie Mac, emphasizing that theFHFA wants a competitive mortgage market where nobody – even Fannie andFreddie – has a set of special rules. That sort of market would be a majorbreak from the past, but it is now the goal:https://thehill.com/blogs/pundits-blog/finance/343084-7-years-in-dodd-frank-still-protects-main-street-from-excessive
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspxCalabria says he’s willing to wipe out Fannie Mae, Freddie Mac shareholdersCalabria says he’s willing to wipe out Fannie Mae, Freddie Mac shareholders
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspx
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspx
https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2019-Strategic-Plan.pdf
https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2019-Strategic-Plan.pdf
https://www.aei.org/wp-content/uploads/2019/06/The-Housing-Lobbys-APOR-Solution-is-fatally-flawed-final.pdf
https://www.aei.org/wp-content/uploads/2019/06/The-Housing-Lobbys-APOR-Solution-is-fatally-flawed-final.pdf
“compared to the duopoly of Fannie Mae and Freddie Mac, movingtoward a more competitive secondary mortgage market – in which thesame rules and regulations apply equally to all – would better serveborrowers and renters. Competition more effectively deliversmarket-affordable prices with customer satisfaction and continualinnovation to improve product quality.”6 Given that Calabria unabashedly wants to work with Congress to create “acompetitive mortgage market with a limited government role,” Americansshould be optimistic that things are heading in the right direction.7 Unfortunately, Calabria and his team will face continuous pressure from allcorners of the housing finance lobby to upset the status quo as little aspossible. That pressure, of course, is the main reason that so little has changedsince the 2008 crisis, and that Fannie and Freddie remain so highly leveraged.8 Many people balk at this suggestion and argue that Fannie and Freddieremain so highly levered because the U.S. Treasury has been taking all of theirprofits, thus preventing the companies from building capital.9 But this narrative omits crucial context, especially the part about how Fannieand Freddie would not exist today without hundreds of billions in taxpayersupport.https://www.forbes.com/sites/steveforbes/2021/02/09/how-covid-19-will-change-public-school-education-forever/
https://www.fhfa.gov/Media/PublicAffairs/Pages/Statement-of-FHFA-Director-Mark-Calabria-on-the-Administrations-Plans-for-Housing-Finance-Reform.aspx
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspx
https://www.forbes.com/sites/norbertmichel/2019/01/14/bipartisan-housing-finance-reform-a-blatant-giveaway-to-special-interests/#462c223225f4
https://www.forbes.com/sites/norbertmichel/2019/01/14/bipartisan-housing-finance-reform-a-blatant-giveaway-to-special-interests/#462c223225f4
https://www.heritage.org/article/new-housing-reform-package-naked-giveaway-special-interests
https://www.heritage.org/article/new-housing-reform-package-naked-giveaway-special-interests
https://www.jchs.harvard.edu/blog/temporarily-ending-the-gse-net-worth-sweep-a-limited-but-important-step-towards-gse-reform/
https://www.jchs.harvard.edu/blog/temporarily-ending-the-gse-net-worth-sweep-a-limited-but-important-step-towards-gse-reform/
https://www.forbes.com/sites/norbertmichel/2019/07/15/the-best-housing-finance-reform-options-for-the-trump-administration/#414c62f87d3f
10 Here’s a quick rundown of the multiple taxpayer bailouts that helpedFannie and Freddie get to where they are today. (More detail is available inthis new Heritage Foundation Backgrounder.)11 In September 2008 Treasury bailed out Fannie and Freddie, promising toshore up each with as much as $100 billion. In return, they forced thecompanies to give Treasury 1 million shares of preferred stock, worth a total of$1 billion. These shares required the companies to pay quarterly cashdividends to the Treasury, and they included a protection device called aliquidation preference. This device means that the companies cannot raisenew equity capital without first paying back the liquidation preference (nowapproximately $200 billion).12 In May of 2009, the companies were still struggling, so Treasury promisedto provide each with up to $200 billion.13 In December 2009 the companies were still struggling, so Treasury changedits commitment formula, allowing it to provide more than $200 billion.14 Even after these three bailouts, Fannie and Freddie were still struggling in2012—so much, that they faced the prospect of borrowing from Treasury justto pay the dividends they owed Treasury.https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-5-6_SPSPA_FannieMae_Amendment_508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-5-6_SPSPA_FannieMae_Amendment_508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-12-24_SPSPA_FreddieMac_Amendment2_N508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-12-24_SPSPA_FreddieMac_Amendment2_N508.pdf
15 Papering over this problem, Treasury amended the agreement once again,this time taking any profit that Fannie and Freddie managed to earn in orderto satisfy the dividend payments.16 It is true that, between 2008 and 2018, Fannie and Freddie paid back about$300 billion to Treasury, roughly $100 billion more in dividends than theyreceived from Treasury. But this fact merely addresses the cash flows. Itoverlooks that Fannie and Freddie were able to pay these dividends only withthe aid of successive bailouts, and it also ignores the risk that taxpayers wereforced to take on through these bailouts.17 Of course, these four bailouts are separate from the additional help thatFannie and Freddie received when the Fed and Treasury purchased trillions ofdollars of Fannie’s and Freddie’s bonds and mortgage backed securities, thusstaving off further losses that could have required even more bailouts.18 Despite all of these bailouts, the federal government chose to place Fannieand Freddie into conservatorship (to preserve their assets) rather thanreceivership (to liquidate their assets and shut them down). Conservatorshipwas a bad choice in 2008 because Fannie and Freddie had blown throughtheir capital buffer and had no prospects for building capital withoutadditional support from taxpayers.https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2012-8-17_SPSPA_FreddieMac_Amendment3_N508.pdf
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2012-8-17_SPSPA_FreddieMac_Amendment3_N508.pdf
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_2.pdf
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_2.pdf
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_1.pdf
http://gcfp.mit.edu/wp-content/uploads/2018/11/Lucas-Bailouts-Nov2018.pdf
https://www.federalreserve.gov/newsevents/pressreleases/monetary20081125b.htm
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_3.pdf
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Current_Market_Data-2016-02-19.pdf
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_4b.pdf
19 Now that the FHFA is taking its job seriously and trying to get Fannie andFreddie out of conservatorship, lack of capital is a major hurdle to a smoothexit. Before they can exit, Fannie and Freddie will have to meet their capitalrequirements (which were suspended throughout the conservatorship), andthe FHFA director will have to classify them as either: (1) adequatelycapitalized, (2) undercapitalized, (3) significantly undercapitalized, or (4)critically undercapitalized.20 As this new paper explains, the authority of the FHFA director to intervenein Fannie’s and Freddie’s operations widens as the capital classificationdeteriorates. Ultimately, the director has the discretionary power to place theGSEs into receivership and liquidate their assets if they are classified ascritically undercapitalized.21 As the paper also shows, Fannie and Freddie are critically undercapitalizedby (combined) approximately $200 billion. This shortfall is a major hurdle toexiting conservatorship, so there was a great buzz when the FHFA andTreasury recently agreed to allow Fannie and Freddie to retain some of theirprofits and maintain capital reserves of $25 billion and $20 billion,respectively.22 If, however, retained earnings are the firms’ only source of capital, it couldtake close to decade to build the required amount. And that’s if everythinggoes well.https://www.law.cornell.edu/uscode/text/12/4614
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.law.cornell.edu/uscode/text/12/4614
https://www.marketwatch.com/story/fannie-freddie-can-hold-more-capital-per-treasury-fhfa-agreement-2019-09-30
23 So it would seem that the companies will have to raise capital from outsidesources, with a public offering. That option, however, also has a few majorhurdles. First, given that $200 billion dwarfs the largest public equityofferings in history, it is not clear that the companies can pull this off even ifthey build capital through retained earnings for the next several years.24 A bigger problem is that the liquidation preference, the mechanism that issupposed to protect taxpayers’ investment, now sits at approximately $200billion. As the agreement with Treasury stands, to protect taxpayers, Fannieand Freddie cannot exit conservatorship until the liquidation preference ispaid off.25 So the companies actually need to raise about $400 billion in equity.26 It may be argued that the most politically expedient option is to provide yetanother bailout so that the companies no longer have to pay off the liquidationpreference. There is, however, a much better solution to this problem.● Reinstate capital standards for Fannie and Freddie. ● Place Fannie and Freddie into receivership and liquidate theirassets because they are critically undercapitalized.27 These moves will cause a firestorm, but it doesn’t really matter: The FHFAdirector has legal authority to take these steps, and it’s what should have beendone in 2008. Besides, anything the administration does to shrink Fannie andhttps://www.investopedia.com/articles/investing/011215/top-10-largest-global-ipos-all-time.asp
https://www.investopedia.com/articles/investing/011215/top-10-largest-global-ipos-all-time.asp
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Issues-Proposed-Rule-on-Enterprise-Capital.aspx
https://www.marketwatch.com/story/fannie-freddie-overhaul-could-mean-windfall-for-preferred-stock-analyst-says-2019-07-12
https://www.marketwatch.com/story/fannie-freddie-overhaul-could-mean-windfall-for-preferred-stock-analyst-says-2019-07-12
Freddie’s footprint will cause a firestorm. (The shareholders can still havetheir day in court no matter what.)28 Liquidating the two companies would have been the right thing to do in2008, and it is still the right thing to do. This government-protected duopolyprevents the housing finance market from being competitive and betterserving customers’ needs. As the FHFA has said, a competitive market helpspeople because it “effectively delivers market-affordable prices with customersatisfaction and continual innovation to improve product quality.”Follow me on Twitter. Norbert Michel I am the Director of the Center for Data Analysis at The Heritage Foundation. I also research issuespertaining to financial markets and monetary policyhttps://www.heritage.org/housing/report/taking-stock-shareholder-lawsuits-no-barrier-gse-dissolution
https://www.heritage.org/housing/report/taking-stock-shareholder-lawsuits-no-barrier-gse-dissolution
https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2019-Strategic-Plan.pdf
https://www.twitter.com/@norbertjmichel
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