Can Fannie, Freddie be overhauled without Congress?

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WASHINGTON — The Trump administration has said more than once that it welcomes legislative reform to fundamentally restructure Fannie Mae and Freddie Mac. But the Federal Housing Finance Agency has also made clear that it stands willing to do the heavy lifting itself.

That begs an obvious question: Would administrative reform of the government-sponsored enterprises be decisive, or would policymakers merely be settling for a backup plan to make up for Congress’ inability to act?

A new report by analyst Karen Shaw Petrou and her firm, Federal Financial Analytics, suggests the FHFA's actions may be sufficient to reform the GSEs. Their analysis warns those skeptical about FHFA Director Mark Calabria’s apparent willingness and authority to overhaul the system not to underestimate the range of options at his disposal.

But an FHFA-led reform effort could be messy, the report concedes.

Calabria lays out "hard-headed options to concluding the GSE conservatorships,” the report says. “Only two goals appear inviolable: the 30-year [fixed-rate mortgage] stays and as much taxpayer risk as possible goes away. As we map out different paths to these goals under current law — and there are several thoroughly plausible ones — we foresee significantly different ranges of market winners and losers.”

Here are some key takeaways from their analysis:

The FHFA has a lot of power to act

Calabria has been clear that he wants to end the conservatorships of Fannie and Freddie. He said last month that his goal is for the mortgage giants to begin the process of exiting federal control and building private capital in 2020, which could include the early stages of a public offering. The FHFA director has long been a proponent of privatizing the two firms, which could mean they compete with other market participants on a more level playing field.

“There's been a lot of people thinking that if Congress doesn't act, then this comfortable status quo continues in perpetuity, and that's a mistake,” Petrou said in an interview. “That's our key takeaway.”

Acknowledging the limits of the FHFA authority, Calabria has said he plans on urging Congress to provide the FHFA with the power to grant more charters, which would fulfill his goal of achieving more competition in the mortgage market.

But Petrou’s analysis indicates that the FHFA’s power under the 2008 Housing And Economic Recovery Act is quite broad.

“The FHFA in consultation with Treasury has tremendous flexibility under current law to recraft the entire U.S. mortgage single and multi-family housing finance system,” she said. “They can do what they want, and how they do it is going to redefine franchise value across the entire mortgage finance sector.”

Calabria has said he could begin negotiating the terms of the preferred stock purchase agreements with Treasury as early as the fall, which could allow the GSEs to retain earnings. In 2012, the FHFA and Treasury altered the senior agreements to require Fannie and Freddie to deliver nearly all of their profits to the Treasury Department in an effort to repay taxpayers, leaving the GSEs with an incredibly small capital cushion of $3 billion each.

The FHFA has authority to put the companies through receivership or form limited-life regulated entities.

“One or both GSEs could go into receivership, creditors could win or lose thereby … and pretty much all the obligations, assets, and products the GSEs now have would go where FHFA and Treasury want based on how much capital each thinks surviving entities must have and the role anticipated for the new-age GSE or GSEs,” the report notes.

In a limited-life regulated entity scenario, the FHFA has “almost unlimited statutory authority” to redefine the business models of both Fannie and Freddie, and the two could end up as very different enterprises than they are today, the firm says.

Calabria could rather quickly take steps to narrow or change the GSEs’ footprints.

“FHFA has considerable discretion to move activities between GSEs in various charter options and to expand or end different business lines in any area not specified by law (e.g., multifamily finance),” the report said. “Calabria has made it clear that he aims to end an array of ‘pilots’ that competitors think transgress HERA’s new-product restrictions. We expect these to end in the near term.”

The report also notes that, despite the Treasury Department’s authority with the conservatorships, “Treasury can’t … do anything even with its contractual power to which FHFA is opposed.”

“But, under current law and given the current confluence of market and macroeconomic factors, Treasury and FHFA have far-reaching control over the conservatorships and what’s to become of them.”

Sufficient GSE capital levels are a moving target

One of the most important decisions Calabria has to make in the short term is on capital standards, Petrou said.

Calabria has said he could begin negotiating the terms of the preferred stock purchase agreements with Treasury as early as the fall, which could allow the GSEs to retain earnings. In 2012, the FHFA and Treasury altered the senior agreements to require Fannie and Freddie to deliver nearly all of their profits to the Treasury Department in an effort to repay taxpayers, leaving the GSEs with an incredibly small capital cushion of $3 billion each.

Meanwhile, a proposal from last year on minimum capital requirements for Fannie and Freddie that was issued under Calabria’s predecessor, Mel Watt, is still in limbo. Calabria is still reviewing the plan, but it falls far short of the bank-like capital standards he has previously pushed for Fannie and Freddie to hold.

“As we showed, FHFA’s proposal is nowhere near the bank-like capital it purported to mandate,” the Federal Financial Analytics report says. “Calabria has recently talked a truly bank-like game, suggesting a 5% ratio that, while still below big-bank leverage ratios, approximates the best-possible risk-based ratio for low-risk mortgages. … How much capital how fast, and how different risk structures are scored will determine not only the pace of privatization, but also a wide swath of the redefined U.S. mortgage market.”

The agencies will have to figure out a balance between risk and capital, Petrou said.

“The less risk the new entities take, the less capital,” she said. “But then you hit the very hard question of, is there sufficient interest and capital in the private markets to take their place? It is a very complicated balancing act.”

The FHFA and Treasury together have to first decide “what kind of GSEs they want” and then design a capital framework around that vision, Petrou said.

There will be both winners and losers in an FHFA-run overhaul

Petrou said the firm's report stemmed from queries by clients in different segments of the market wanting to know what the different GSE approaches undertaken by the administration could look like.

“People have come in and said, 'Am I a winner? Am I a loser?' " she said. “And that's where we need our flying flow charts, because the answer for each type of franchise is different.”

Under a receivership scenario, both the FHFA and Treasury would have a lot of discretion to decide the fate of different players based on the amount of capital that is deemed necessary for a successor institution.

The process to some extent sounds like powers granted to the Federal Deposit Insurance Corp. after the crisis to unwind failing systemically important banks.

“One or both GSEs could go into receivership, creditors could win or lose thereby, securitizations could emerge out the other end in new [unified mortgage-backed securities], the [common securitization platform] could go its own way, and pretty much all the obligations, assets, and products the GSEs now have would go where the FHFA and Treasury want based on how much capital each thinks surviving entities must have and the role anticipated for the new-age GSE or GSEs,” the report said.

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GSE reform GSEs Housing finance reform Minimum capital requirements Risk management Mark Calabria FHFA Fannie Mae Freddie Mac Treasury Department
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