FHFA’s Strategic Plan for Fannie and Freddie

The Federal Housing Finance Agency released its Strategic Plan for fiscal years 2018-2022 for public input. As discussed in yesterday’s post, Director Watt is very focused on maintaining the health of Fannie Mae and Freddie Mac. The Strategic Plan reiterates that focus:

As conservator of the Enterprises, FHFA will also promote stability by working to preserve and conserve the Enterprises’ assets and business operations. Additionally, FHFA will encourage the Enterprises and the housing industry to adopt standards and practices that promote market and stakeholder confidence. (8)

The Plan goes into depth to describe the FHFA’s role as conservator:

The Enterprises were placed into conservatorships in September 2008 in the midst of a severe financial crisis. Their ongoing participation in the housing finance market has been an important factor in maintaining market liquidity and stability. Conservatorship permitted the U.S. Government to take greater control over management of the Enterprises and gave investors in the Enterprises’ debt and MBS confidence that the Enterprises would have the capacity to honor their financial obligations. As conservator, FHFA establishes restrictions and expectations for the Enterprises’ boards and for their managements while authorizing them to conduct the Enterprises’ day-to-day operations.

As detailed earlier, FHFA’s authority as both regulator and conservator of the Enterprises is based upon statutory mandates. FHFA, acting as regulator and conservator, must follow the mandates assigned to it by statute and the missions assigned to the Enterprises by their charters. Congress may choose to revise the statutory mandates governing the Enterprises at any time.

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The Enterprises are also parties to PSPAs with the Treasury Department. Under the PSPAs, the Enterprises are provided U.S. taxpayer backing with explicit dollar limits. The PSPA commitment still available to Fannie Mae is $117.6 billion and the commitment still available to Freddie Mac is $140.5 billion. Additional draws would reduce these commitments, and dividend payments do not replenish or increase the commitments under the terms of the PSPAs. Starting in 2013, the PSPAs provided each Enterprise with a capital buffer of $3 billion to protect each Enterprise against making additional draws of taxpayer support in the event of an operating loss in any quarter, and the PSPAs provide mandated declines of $600 million each year to these capital buffers. On January 1, 2017, each Enterprise’s capital buffer declined to $600 million and the capital buffer is scheduled to decline to zero on January 1, 2018.

FHFA continues to encourage Congress to complete the important work of housing finance reform. FHFA has reiterated the urgency of reform and that it is up to Congress to determine what future, if any, the Enterprises will have in the future housing finance system. (16-17)

Reading between the lines, I see the FHFA under Watt doing whatever it has to in order to maintain stability and liquidity in the mortgage markets. If Congress does not act, if the Treasury does not act, I think that Director Watt will go it alone and do what it takes to maintain Fannie and Freddie’s reputation with mortgage lenders and MBS investors.

Watt’s Happening with Fannie and Freddie?

FHFA Director Watt

Federal Housing Finance Agency Director Watt testified before the House Committee on Financial Services today and gave a good overview of the decade-long conservatorship of Fannie and Freddie.  He also gave some sense of the urgency of coming up with at least a stopgap measure before the two companies’ capital buffer drops to zero at the end of the year pursuant to the terms of the Senior Preferred Stock Purchase Agreements (PSPAs) that govern the two companies’ relationship with the Treasury. He stated that it would

be a serious misconception for members of this Committee, or for anyone else, to consider any actions FHFA may take as conservator to avoid additional draws of taxpayer support either as interference with the prerogatives of Congress, as an effort to influence the outcome of housing finance reform, or as a step toward recap and release. FHFA’s actions would be taken solely to avoid a draw during conservatorship.

This signifies to me that he is planning on doing something other than reducing the capital buffer to $0.  As far as I can tell, Watt is playing a game of chicken with Congress — if you do not act, I will.

It is not clear to me clear how much authority Watt has or thinks he has to change the rules relating to the capital buffer. Does he think that he could act inconsistent with the PSPAa and withhold capital?  I have not seen a legal argument that says he could.  Is he willing to do it and be sued by Treasury?  These are speculative questions, but I do think that he has laid the groundwork for taking action if Congress and Treasury do not.

It does not seem to me that he was much wiggle room according to the terms of the PSPAs themselves, except perhaps to delay making the net worth sweep at the end of this year by converting it to an annual sweep or by some other mechanism.  That will be a short-term fix.

Given his strong language — “FHFA’s actions would be taken solely to avoid a draw during conservatorship” — I think he might be prepared to take an action that is inconsistent with the plain language of the PSPAs in order to act in a way that he thinks is consistent with his duty as the conservator.  This is less risky than it sounds because the only party that would seem to have standing to sue would be the Treasury, the counter-party to the PSPAs.  One could imagine that the Treasury would prefer to negotiate a response with the FHFA or await Watt’s departure rather than to have a judge decide the issue.  One could also imagine that Treasury would go along with the FHFA without explicitly condoning its actions, particularly if its actions soothed a turbulent market for Fannie and Freddie mortgage-backed securities.

Watt has consistently signaled that he will act if no other responsible party does and he emphasized that again today.

Community Bankers and GSE Reform

The Independent Community Bankers of America have release ICBA Principles for GSE Reform and a Way Forward. Although this paper is not as well thought-out as that of the Mortgage Bankers Association, it is worth a look in order to understand what drives community bankers.

The paper states that the smaller community banks

depend on the GSEs for direct access to the secondary market without having to sell their loans through a larger financial institution that competes with them. The GSEs help support the community bank business model of good local service by allowing them to retain the servicing on the loans they sell, which helps keep delinquencies and foreclosures low. And unlike other private investors or aggregators, the GSEs have a mandate to serve all markets at all times. This they have done, in contrast to some private investors and aggregators that severely curtailed their business in smaller and economically distressed markets, leaving those community bank sellers to find other outlets for their loan sales. (1)

The ICBA sets forth a set of principles to guide GSE reform, including

  • The GSEs must be allowed to rebuild their capital buffers.
  • Lenders should have competitive, equal, direct access on a single-
    loan basis.
  • Capital, liquidity, and reliability are essential.
  • Credit risk transfers must meet targeted economic returns.
  • An explicit government guarantee on GSE MBS is needed.
  • The TBA market for GSE MBS must be preserved.
  • Strong oversight from a single regulator will promote sound operation.
  • Originators must have the option to retain servicing, and servicing fees must be reasonable.
  • Complexity should not force consolidation.
  • GSE assets must not be sold or transferred to the private market.
  • The purpose and activities of the GSEs should be appropriately limited.
  • GSE shareholder rights must be upheld.

This paper does not really provide a path forward for GSE reform, but it does clearly state the needs of community bankers. That is valuable in itself. There is also a lot of common sense behind the principles they espouse. But it is a pretty conservative document, working from the premise that the current system is pretty good so if it ain’t broke, why fix it? I think other stakeholders believe the system is way more broke than community bankers believe it to be.

There are also some puzzlers in it this paper. Why the focus on GSE shareholder rights? Is it because many community banks held GSE stock before the financial crisis? Are there other reasons that this is one of their main principles?

Hopefully, over time community bankers will flesh out the thinking that went into this paper in order to fuel an informed debate on the future of the housing finance market.