Tag Archives: financial crisis

Trump’s Plans to Privatize Fannie and Freddie

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from Cato Institute website, https://www.cato.org/people/mark-calabria

Mark Calabria, OMB Associate Director for Treasury, Housing, and Commerce

I was interviewed on  WBUR-FM’s On Point (distributed by American Public Radio), hosted by Meghna Chakrabarti for an episode on How Trump Plans To Get Government out of the Mortgage Business. The link has the recording of the show as well as a transcript.

The transcript of the interview starts,

CHAKRABARTI: Now that President Trump is back in the White House, it seems that he intends to get the job done this time around. Mark Calabria has returned to Trump’s administration, this time working on housing policy at the Office of Management and Budget. Bill Pulte is now director of FHFA, and he just made the highly unusual move of appointing himself chair of both Fannie Mae and Freddie Mac, making the regulator and the regulated basically the same.

Pulte also fired 14 of the 25 sitting board members at Fannie and Freddie. A shakeup many are suspecting is a first step in leading these two companies out of government control and into privatization. We’re talking about a huge part of the U.S. economy that underpins the housing market. So this hour, we want to explore what privatization of Fannie and Freddie actually means, what it should look like, and how it might have an impact on homeowners and the housing market.

So to do that, David Reiss joins us. He’s a clinical professor of law at Cornell Law School and Cornell Tech, an expert in housing finance and policy. Professor Reiss, welcome to On Point.

DAVID REISS: Meghna, thank you so much.

CHAKRABARTI: I have to tell you that I actually can’t believe that it’s been 17 years since the financial crisis of 2008.

Let’s dust off the memory banks professor and go back to before 2008 and start there. Can you just remind us like what Fannie Mae and Freddie Mac were, what their purpose was, who owned them, et cetera?

REISS: I’m gonna go even a little bit further back than Fannie and Freddie’s creation, because I think it’s really gonna help people visualize what’s at stake here.

And if you think back to the 19th century and somebody was trying to buy a house, they didn’t have that many options. A house has always been a very expensive thing to buy, so they need to borrow some money to buy a house. And how could you do that?

Maybe if you’re rich, you could do it, or had a rich uncle, but otherwise you need to go to somebody who has capital and that you could borrow it and give them some interest in return. And pay them back over time, and be able to live in that house while you’re paying back the amount of money that you borrowed. And so if people think of It’s a Wonderful Life where there’s the Bailey Brothers building in loans and where they, people deposit their small savings into the buildings and loan.

And then some people are then able to borrow some money from the buildings and loan for mortgages. And there’s the famous scene where there’s a panic at the bank. And Jimmy Stewart says, Mrs. Kennedy, your money is in Mrs. Smith’s house. And Mrs. Smith, your money is in Ms. Macklin’s house.

And that’s the way it was done in the 19th century and the early 20th century. But there were real limitations to that. Sometimes communities didn’t have a lot of capital to lend people, so maybe in out west or in the Midwest there wasn’t a lot of capital, like there might’ve been back east in Boston or New York.

And so people who could have handled the mortgage just didn’t have access to it. It was like they were living in a dry area, and the fresh flowing credit didn’t reach their dry community. So during the Great Depression and the New Deal the government started to intervene, to spread credit out across the country in a way that kind of provided liquidity to all the communities where people wanted to borrow.

And Fannie Mae was a creature of the New Deal, but really took off in the ’70s along with its sibling Freddie Mac. And effectively, what those two companies were designed by Congress to do was to ensure that capital could go across state borders in a way that banks were typically not allowed to do. And they effectively created at first a national market for mortgage credit, and effectively when they access the global credit markets over time, an international global market for credit. So they’re really intermediaries.

Federal Home Loan Banks’ Liquidity Role During Financial Crises

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The historic Federal Home Loan Bank Board Building            AgnosticPreachersKid CC BY-SA 4.0

The U.S. Government Accountability Office (GAO) has invited me to participate in a review of the Federal Home Loan Banks’ Liquidity Role During Financial Crises. I have previously written about the FHLBs here. The invite reads in part,

GAO is an independent, nonpartisan federal agency that supports Congress by evaluating federal programs and activities. In response to a request from the House Committee on Financial Services, our team is conducting a review of the Federal Home Loan Banks’ (FHLBank) liquidity role during financial crises.

As part of our work, we plan to provide Congress and the public more information on the strengths, limitations, and feasibility of certain changes that academics, interest groups, and others have suggested to address perceived issues with FHLBank lending during crises. We identified the changes through a review of academic, trade, and grey (dissertations, blog posts, etc.) literature since 2007. We then narrowed the list down to a shorter list of changes for further discussion. While we recognize there is currently substantial discussion around the FHLBanks’ housing mission and membership, we are focusing on FHLBanks’ lending to banks. Please note that the changes to be discussed are not GAO recommendations.

The GAO is seeking input “from individuals, organizations, federal agencies, and FHLBanks on the list of changes to address concerns with FHLBank lending during crises.” I had previously written that while the FHLBank System

was originally designed to support homeownership, it has morphed into a provider of liquidity for large financial institutions.

Banks like JPMorgan Chase & Co., Bank of America Corp., Citibank NA and Wells Fargo & Co. are among its biggest beneficiaries and homeownership is only incidentally supported by their involvement with it.

As part of the comprehensive review of the system, we should give thought to at least changing the name of the system so that it cannot trade on its history as a supporter of affordable homeownership. But we should go even farther and give some thought to spinning off its functions into other parts of the federal financial infrastructure as its functions are redundant with theirs.

This GAO review is a good start to subjecting the System to such a comprehensive review!

Shaping the NYC Skyline

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David Shamshovich, Camila Almeida, and Brenda Slochowsky just posted an episode of their podcast, Shaping The NYC Skyline. In this episode (mysteriously titled “Uncovering the Whole Elephant: The Evolution of Real Estate” — mysterious, that is, until you listen to it).

They interviewed me back in May when I was at Brooklyn Law School. The Apple podcast write-up states

Buckle up, Skyliners, for an illuminating episode featuring Professor David Reiss, formerly of Brooklyn Law School and now at Cornell Law School and Cornell Tech. Renowned for his expertise in real estate finance and community development, Professor Reiss has shaped countless legal minds, including our very own David Shamshovich, with his practical approach to complex concepts. This episode offers a rare glimpse into his journey from NYU Law School and prestigious law firms to his influential role in academia, where he has spent over two decades demystifying real property law.

Starting as an associate at major law firms, David soon discovered his passion for teaching. This led him to Brooklyn Law School, where he served as a professor and the founding director of the Community Development Clinic. His dedication to education is matched by his commitment to real-world impact, evidenced by his work with not-for-profits and his previous role as Chair of the NYC Rent Guidelines Board.

In this episode, David delves into the critical role the Community Development Clinic has played in providing hands-on experience to students, preparing them for real-world transactional and corporate real estate challenges. He emphasizes the importance of consumer protection in the housing market, drawing lessons from the subprime mortgage crisis. David also shares insights on the evolution of real estate finance, discussing the transition from mutual savings to sophisticated global capital markets, and the lasting impacts of historical events like the Great Depression and the 2007-2008 financial crisis.

Listeners will gain a deeper understanding of how these complex systems work and the importance of regulatory frameworks in protecting consumers and maintaining market stability. David’s ability to simplify intricate concepts has made him a beloved figure among students and colleagues alike, earning him a reputation as one of the best in his field.

Join us as we explore Professor David Reiss’s extraordinary career, his innovative approach to legal education, and his deep belief in the power of practical experience. Without further ado, we present Professor David Reiss, a beacon of knowledge and a guiding light in Shaping the NYC Skyline!

More on Shaping the NYC Skyline:

Website – https://www.seidenschein.com/podcast/

LinkedIn – https://www.linkedin.com/company/shaping-the-nyc-skyline/

Instagram – Shaping the NYC Skyline (@shapingthenycskyline)

YouTube – https://www.youtube.com/@ShapingtheNYCSkyline

Insuring Homeownership — Best of the ABA

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The American Bar Association selected my short article, Insuring Sustainable Homeownership, as part of “The Best of ABA Sections”–a compilation of some of the best articles published by the ABA’s sections, forums, and divisions.  It was published in the ABA’s journal, GPSolo and it is drawn from Insuring Sustainable Homeownership,  published in  20 (March/April 2018).  It opens,

The Federal Housing Administration (FHA) has suffered from many of the same unrealistic underwriting assumptions that did in so many lenders during the 2000s. It, too, was harmed by a housing market as bad as any seen since the Great Depression. As a result, the federal government announced in 2013 that the FHA would require the first bailout in its history. At the same time that it faced these financial challenges, the FHA came under attack for poor execution of some of its policies attempting to expand homeownership opportunities. This article examines the criticism that has been leveled at FHA and the goals the agency should pursue.

Money, Government and Mortgages

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photo by By Chris McAndrew - https://api.parliament.uk/Live/photo/F7tZ5nm6.jpeg?crop=MCU_3:4&quality=80&download=trueGallery: https://beta.parliament.uk/media/F7tZ5nm6, CC BY 3.0, https://commons.wikimedia.org/w/index.php?curid=67598699

Robert Skidelsky

I just finished reading Money and Government by Robert Skidelsky (2018).  It is a bit tough in parts for non-economists, but it is a great read for those trying to understand the appropriate relationship between economic theory and government policy.  While that may sound dry indeed, it is of key importance to the design of a post-Financial Crisis world regulatory order.

The book delves into the the “Mysteries of Money,” providing a short history of a deceptively simple topic that I continue to find to be difficult to wrap my head around:  what exactly is money and what can you do with it?  The book then goes into some inside baseball analysis of the history of economic thought.  I skimmed this section because it related some pretty technical debates among early economists to set up its more accessible discussion of Keynesian economics and its challenger, Milton Friedman-led Monetarism.  The book then takes a look at how economic theory impacted governments’ responses to the Financial Crisis, for good and for ill.

I think readers of this blog would be most interested by Skidelsky’s insights in the final section, where he tries to sketch “A New Macroeconomics.”  He asks and answers the question, “What Should Governments Do and Why?”  He wants to make banking safe and address inequality.

Readers of this blog will be particularly interested in his analysis and  recommendations for the mortgage market.  He argues that the “main theoretical mistake behind securitization was the assumption that securities are always liquid:  they can always be sold quickly and without (much) loss.”  (328)  The Financial Crisis demonstrated in spades that this was not true.  He argues that “[c]ompelling banks to hold mortgages for a period of years” is the solution to this particular problem.  (363) I do not think that I agree with this solution, but as he argues his point at a high level of generality, it probably is best to say that the devil will be in the details for any reform program in this sphere.

I found his analysis of populism compelling.  He argues that the “political divide between right and left . . . is increasingly overshadowed by one between nationalism and globalism.” (372)  I won’t go into the details here, but he has a very trenchant analysis of how the economist’s theoretical Homo economicus fails to account for important aspects of our humanity as individuals, as members of groups and as citizens of nation-states.  He warns that we do that at our peril:  citizens of democracies will punish their leaders for failing to take into account their complex need to flourish in all of those ways that economists can reduce down to one-dimensional units of measurement, such as “utility.”

Yale University Press says that the book is out of print, but Amazon has paperback copies available if you dig a bit on the book’s web page (and, of course, there are Kindle versions available for those so inclined).  I recommend that you get yourself a copy.

GSE Shareholders Floored, Again

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The United States Court of Appeals for the Eighth Circuit issued an opinion in Saxton v. FHFA (No. 17-1727, Aug. 23, 2018). The Eighth Circuit joins the Fifth, Sixth, Seventh and D.C. Circuits in rejecting the arguments of Fannie and Freddie shareholders that the Federal Housing Finance Agency exceeded its authority as conservator of Fannie Mae and Freddie Mac and acted arbitrarily and capriciously. The Court provides the following overview:

     The financial crisis of 2008 prompted Congress to take several actions to fend off economic disaster. One of those measures propped up Fannie Mae and Freddie Mac. Fannie and Freddie, which were founded by Congress back in 1938 and 1970, buy home mortgages from lenders, thereby freeing lenders to make more loans. See generally 12 U.S.C. § 4501. Although established by Congress, Fannie and Freddie operate like private companies: they have shareholders, boards of directors, and executives appointed by those boards. But Fannie and Freddie also have something most private businesses do not: the backing of the United States Treasury. 

     In 2008, with the mortgage meltdown at full tilt, Congress enacted the Housing and Economic Recovery Act (HERA or the Act). HERA created the Federal Housing Finance Agency (FHFA), and gave it the power to appoint itself either conservator or receiver of Fannie or Freddie should either company become critically undercapitalized. 12 U.S.C. § 4617(a)(2), (4). The Act includes a provision limiting judicial review: “Except as  provided in this section or at the request of the Director, no court may take any action to restrain or affect the exercise of powers or functions of the [FHFA] as a conservator or a receiver.” Id. § 4617(f). 

     Shortly after the Act’s passage, FHFA determined that both Fannie and Freddie were critically undercapitalized and appointed itself conservator. FHFA then entered an agreement with the U.S. Department of the Treasury whereby Treasury would acquire specially-created preferred stock and, in exchange, would make hundreds of billions of dollars in capital available to Fannie and Freddie. The idea was that Fannie and Freddie would exit conservatorship when they reimbursed the Treasury.

     But Fannie and Freddie remain under FHFA’s conservatorship today. Since the conservatorship began, FHFA and Treasury have amended their agreement several times. In the most recent amendment, FHFA agreed that, each quarter, Fannie and Freddie would pay to Treasury their entire net worth, minus a small buffer. This so-called “net worth sweep” is the basis of this litigation. 

     Three owners of Fannie and Freddie common stock sued FHFA and Treasury, claiming they had exceeded their powers under HERA and acted arbitrarily and capriciously by agreeing to the net worth sweep. The shareholders sought only an injunction setting aside the net worth sweep; they dismissed a claim seeking money damages. Relying on the D.C. Circuit’s opinion in Perry Capital LLC v. Mnuchin, 864 F.3d 591 (D.C. Cir. 2017), the district court dismissed the suit.

What amazes me as a longtime watcher of the GSE litigation is how supposedly dispassionate investors lose their heads when it comes to the GSE lawsuits. They cannot seem to fathom that judges will come to a different conclusion regarding HERA’s limitation on judicial review.

While I do not rule out that the Supreme Court could find otherwise, particularly if Judge Kavanaugh is confirmed, it seems like this unbroken string of losses should provide some sort of wake up call for GSE shareholders. But somehow, I doubt that it will.

Fintech and Mortgage Lending

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image by InvestmentZen, www.investmentzen.com

The Trump Administration released its fourth and final report on Nonbank Financials, Fintech, and Innovation in its A Financial System That Creates Economic Opportunity series. The report differs from the previous three as it does not throw the Consumer Financial Protection Bureau under the bus when it comes to the regulation of mortgage lending.

The report highlights how nonbank mortgage lenders, early adopters of fintech, have taken an immense amount of market share from traditional mortgage lenders like banks:

Treasury recognizes that the primary residential mortgage market has experienced a fundamental shift in composition since the financial crisis, as traditional deposit-based lender-servicers have ceded sizable market share to nonbank financial firms, with the latter now accounting for approximately half of new originations. Some of this shift has been driven by the post-crisis regulatory environment, including enforcement actions brought under the False Claims Act for violations related to government loan insurance programs. Additionally, many nonbank lenders have benefitted from early adoption of financial technology innovations that speed up and simplify loan application and approval at the front-end of the mortgage origination process. Policymakers should address regulatory challenges that discourage broad primary market participation and inhibit the adoption of  technological developments with the potential to improve the customer experience, shorten origination timelines, facilitate efficient loss mitigation, and generally deliver a more reliable, lower cost mortgage product. (11)

I am not sure that the report has its causes and effects exactly right. For instance, why would banks be more disincentivized than other financial institutions because of False Claims Act lawsuits? Is the argument that banks have superior lending opportunities that are not open to nonbank mortgage lenders? If so, is that market segmentation such a bad thing? 

That being said, I think the report is right to highlight the impact of fintech on the contemporary mortgage lending environment. Consumers will certainly benefit from a shorter and more streamlined mortgage application process.