Why GSE Recapitalization Talk Is Premature
The notion that the Trump administration should recapitalize government-sponsored enterprises Fannie Mae and Freddie Mac as a predicate to reforming them, risks the political overcorrection that proponents of this idea claim to want to avoid, while ignoring the critically-needed reforms necessary to ensure a stable housing finance system through all economic cycles.
First, proponents of "recap and release" misread the political risks and the depth of interest that key representatives and senators have in determining the long-term future of the GSEs. In early 2016, the largest housing groups (National Association of Realtors, National Association of Home Builders, American Bankers Association, Mortgage Bankers Association and National Housing Conference) united in a joint letter to voice our collective view that "[P]olicymakers need to continue to focus on the paramount objective of fixing the structural flaws that led to the breakdown of the housing finance system — the only outcome that will protect taxpayers, reserve access to credit, and ensure a stable housing finance system."
Moreover, recapitalization-before-reform could create an overreaction in response that could end up being harmful to these two companies and the housing finance system that relies on them. Any isolated move to modify the preferred stock purchase agreement and the net worth sweep might create a similar response to what we saw when the Federal Housing Finance Agency attempted to modify the pay of the CEOs of the GSEs. In that instance, Congress moved swiftly to pass an overwhelmingly bipartisan bill which established pay caps for the two CEOs.
Similarly, Congress overwhelmingly approved a bill to limit the Treasury's ability to execute any transaction using the government-owned GSE preferred shares absent an explicit act of Congress. Finally, a report this past fall from the Congressional Budget Office made clear that any modification of the sweep would negatively impact both the federal budget and the taxpayer. Congress has made clear in its actions that the only path to meaningful reform is through the legislative branch.
Second, the proponents of "recapitalization first" overestimate the risks of a GSE draw. The GSEs are backed by an explicit line of credit (not too different from the Federal Housing Administration) of more than $200 billion that is held explicitly by the Treasury Department. With that backstop, the risk of an adverse market reaction to a draw is minimal. In any recapitalization effort, it would take decades for the GSEs to build that amount of depth of backstop. Given the existing line of credit, it's just not necessary and the focus only diverts attention from the real work that is needed to resolve the stalemate of conservatorship.
We will continue to focus on securing responsible housing finance reform that ends long-term uncertainty over the future of the GSEs and protects the important role they play in our financial system. Recapitalization without reform risks an unnecessary Congressional overreaction, especially when any retention of capital would be insignificant compared to the existing massive line of credit that already explicitly protects the companies.
It is time to resolve conservatorship through a responsible reform legislative effort that focuses on core principles of protecting the functions that these companies provide in bringing liquidity and availability to the U.S. mortgage market while protecting taxpayers as well. These principles include insuring a level playing field for all lenders — large and small, bank and nonbank — with no special deals for anyone, deeper first-loss private capital ahead of an explicit government insurance fund covering only catastrophic risk with a full guaranty on the mortgage-backed security, a commitment to responsibly serve all markets, and appropriate limits to their retained portfolios that focus on maintaining a cash window and managing defaulted loans.
The concerns by some about the stability of these two important companies with calls to retain capital are likely founded on good intention but could risk a strong reaction just like we have seen before.
Capital is not a near-term risk to these two companies — the line of credit guarantees that. The real risk is the uncertainty of continued, long-term conservatorship. Congressional reform before recapitalization is the proper path forward.
David Stevens is the president and CEO of the Mortgage Bankers Association.