Tag Archives: capital reserve

Fannie, Freddie & The Affordable Housing Feint

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Robert J. Shapiro

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Elaine C. Kamarck

 

 

 

 

 

Robert J. Shapiro and Elaine C. Kamarck have posted A Strategy to Promote Affordable Housing for All Americans By Recapitalizing Fannie Mae and Freddie Mac. While it presents as a plan to fund affordable housing, the biggest winners would be speculators who bought up shares of Fannie and Freddie stock and who may end up with nothing if a plan like this is not adopted.  The Executive Summary states that

This study presents a strategy for ending the current conservatorship and majority government ownership of Fannie and Freddie in a way that will enable them, once again, to effectively promote greater homeownership by average Americans and greater access to affordable housing by low-income households. This strategy includes regulation of both enterprises to prevent a recurrence of their effective insolvency in 2008 and the associated bailouts, including 4.0% capital reserves, regular financial monitoring, examinations and risk assessments by the Federal Housing Finance Agency (FHFA), as dictated by HERA. Notably, an internal Treasury analysis in 2011 recommended capital requirements, consistent with the Basel III accords, of 3.0% to 4.0%. In addition, the President should name a substantial share of the boards of both enterprises, to act as public interest directors. The strategy has four basic elements to ensure that Fannie and Freddie can rebuild the capital required to responsibly carry out their basic missions, absorb losses from future housing downturns, and expand their efforts to support access to affordable housing for all households:

  • In recognition of Fannie and Freddie’s repayments to the Treasury of $239 billion, some $50 billion more than they received in bailout payments, the Treasury would write off any remaining balance owed by the enterprises under the “Preferred Stock Purchase Agreements” (PSPAs).
  • The Treasury also would end its quarterly claim or “sweep” of the profits earned by Fannie and Freddie, so their future retained earnings can be used to build their capital reserves.
  • Fannie and Freddie also should raise roughly $100 billion in additional capital through several rounds of new common stock sales into the market.
  • The Treasury should transfer its warrants for 79.9% of Fannie and Freddie’s current common shares to the HTF [Housing Trust Fund] and the CMF [Capital Magnet Fund], which could sell the shares in a series of secondary stock offerings and use the proceeds, estimated at $100 billion, to endow their efforts to expand access to affordable housing for even very low-income households.

Under this strategy, Fannie and Freddie could once again ensure the liquidity and stability of U.S. housing markets, under prudent financial constraints and less exposure to the risks of mortgage defaults. The strategy would dilute the common shares holdings of current private investors from 20% to 10%, while increasing their value as Fannie and Freddie restore and claim their profitability. Finally, the strategy would establish very substantial support through the HTF and CPM for state programs that increase access to affordable rental housing by very low-income American and affordable home ownership by low-to-moderate income households.

Wow — there is a lot that is very bad about this plan.  Where to begin? First, we would return to the same public/private hybrid model for Fannie and Freddie that got us into so much trouble to begin with.

Second, it would it would reward speculators in Fannie and Freddie stock. That is not terrible in itself, but the question would be — why would you want to? The reason given here would be to put a massive amount of money into affordable housing. That seems like a good rationale, until you realize that that money would just be an accounting move from one federal government account to another. It does not expand the pie, it just makes one slice bigger and one slice smaller. This is a good way to get buy-in from some constituencies in the housing industry, but from a broader public policy perspective, it is just a shuffling around of resources.

There’s more to say, but this blog post has gone on long enough. Fannie and Freddie need to be reformed, but this is not the way to do it.

 

Another Fannie/Freddie Bailout?

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The Federal Housing Finance Agency Office of the Inspector General has issued a White Paper Report, The Continued Profitability of Fannie Mae and Freddie Mac Is Not Assured. The Executive Summary opens,

Fannie Mae and Freddie Mac (collectively, the Enterprises) returned to profitability in 2012 after successive years of losses. Their improved financial performance is encouraging; however, their continued profitability is not assured. The mortgage industry is complex, cyclical, and sensitive to changes in economic conditions, mortgage rates, house prices, and other factors. The Enterprises have acknowledged in their public disclosures that adverse market and other changes could lead to additional losses and that their financial results are subject to significant variability from period to period.

Notwithstanding the Enterprises’ recent positive financial results, they face many challenges. For example:

  The Enterprises must reduce the size of their retained investment portfolios over the next few years pursuant to the terms of agreements with the U.S. Department of Treasury (Treasury) and additional limits from FHFA. Declines in the size of these portfolios will reduce portfolio earnings over the long term. These portfolios have been the Enterprises’ largest source of earnings in the past.

  Core earnings from the Enterprises’ business segments—single-family guarantee, multifamily, and investments—comprised only 40% of net income in 2013. Sixty percent of the Enterprises’ net income came from non-recurring tax-related items and large settlements of legal actions and business disputes, which are not sustainable sources of revenue. Core earnings comprised 55% of net income in 2014.

  The Enterprises are unable to accumulate a financial cushion to absorb future losses. Pursuant to the terms of agreements with Treasury, the Enterprises are required to pay Treasury each quarter a dividend equal to the excess of their net worth over an applicable capital reserve amount. The applicable capital reserve amount decreases to zero by January 1, 2018.

  Stress test results released by the Federal Housing Finance Agency (FHFA) in April 2014 indicate that the Enterprises, under the worst scenario—a scenario generally akin to the recent financial crisis— would require additional Treasury draws of either $84.4 billion or $190 billion, depending on the treatment of deferred tax assets, through the end of the stress test period, which is the fourth quarter of 2015.

  Absent Congressional action, or a change in FHFA’s current strategy, the conservatorships will go on indefinitely. The Enterprises’ future status is beyond their control. At present, it appears that Congressional action will be needed to define what role, if any, the Enterprises play in the housing finance system. (1-2)

While I am overall sympathetic to the underlying message of this white paper — Reform Fannie and Freddie Now! — I think it is somewhat misleading. Fannie and Freddie have been sending billions of dollars to the Treasury that exceed the amount of support that they received during the financial crisis. Before we could talk about a second taxpayer bailout, I think we would have to credit them with those excess payments.

That being said, the Obama Administration and Congress have left Fannie and Freddie to linger for far too long in conservatorship limbo. I have no doubt that this state of affairs will contribute to some kind of crisis for the two companies, so we should support some kind of exit strategy that gets implemented sooner rather than later. Inaction is the greatest threat to Fannie and Freddie, and to the housing finance system itself.