Tag Archives: hybrid

Will Congress Recap and Release Fannie & Freddie?

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Senator Shelby

Senator Shelby

Richard Shelby, the Chair of the Senate Committee on Banking, Housing, and Urban Affairs asked the Congressional Budget Office to prepare a report on The Effects of Increasing Fannie Mae’s and Freddie Mac’s Capital. The report acknowledges that the legislative reform of the two companies is going nowhere, but it analyzed one potential reform option that shares characteristics with some of the GSE reform bills that have been introduced over the years. The option studied by the CBO contemplates recapitalizing the two companies along the following lines:

each GSE would be allowed to retain an average of $5 billion of its profits annually and would thus increase its capital by up to $50 billion over 10 years. The government’s commitment to purchase more senior preferred stock from Fannie Mae and Freddie Mac if necessary to ensure that they maintain a positive net worth would remain in place. In addition, the GSEs would invest the profits that they retained under the option in Treasury securities, and returns on those securities would raise the GSEs’ income. Through its holdings of senior preferred stock, the government would continue to have a claim to the GSEs’ net worth ahead of other stockholders. (2, footnote omitted)

The CBO’s mandate is “to provide objective, impartial analysis,” but this report seems like it is laying the groundwork for a proposal to recapitalize Fannie and Freddie so that they can be released from conservatorship. Most policy analysts (as opposed to investors in the two companies) think that allowing the two companies to return to their prior lives as public/private hybrids is a terrible idea. It is too difficult for them to simultaneously answer to the federal regulators who set their public mission as well as to the private shareholders who would ultimately own them. And, if we were to take this path, the taxpayer would be left holding the bag once again if they were to ever need another bailout.

I think that Senator Shelby has done GSE reform a disservice by looking at this recapitalization option out of context. What we need is an analysis of a compromise plan that Congress can pass once the election is settled. Otherwise we are just leaving the two companies to limp along in conservatorship, slouching toward their next, yet unknown, crisis. Or worse, we are preparing to release them from conservatorship to go back to business as usual. Both of those options are very bad. Congress owes it to the American people to create a workable housing finance system for the 21st century that does not repeat our past mistakes.

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.

 

The (R)evolution of Single-Family Rental Securitization

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Kroll Bond Rating Agency distributed its Single-Family Rental Securitization Methodology. Because this is a new asset class, it is interesting to watch how rating agency’s assess the risks inherent in it. And it will be interesting, of course, to evaluate down the road whether they got it right or not. The Methodology states that

Single-family Rental (SFR) securitizations are a new class of asset-backed securities with characteristics of both commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS). Like CMBS, the primary source of certificateholder distributions during the term of an SFR transaction are loan debt service payments that are generated by income producing real estate collateral. Also like CMBS, there is an element of balloon risk, as SFR loans do not fully amortize over their terms, and the repayment of ultimate principal on the certificates is dependent upon a successful refinance of the loan or loans that serve as trust collateral. However, there is a broader source of demand for the single-family homes underlying an SFR securitization, which can be sold into the vast market for owner-occupied homes, totaling approximately 79 million units. In the event that the pool of single-family homes backing an SFR securitization needs to be partially or entirely liquidated due to an event of default either during the loan’s term or at the loan’s maturity, the expected recovery from such a distressed sale of homes would be largely determined by the conditions in the larger market for single-family homes, which is a primary focus of RMBS analysis.

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the SFR securitization market is currently characterized by large institutional sponsors that have engaged in purchasing and refurbishing large numbers of single-family homes in distressed markets over relatively short periods of time.

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As this is an evolving asset class, we will modify or adjust our methodology to address new transaction features as they emerge. SFR securitizations to date have been collateralized by a single large loan that is in turn secured by mortgages on several thousand income producing single-family homes. While this methodology is designed for this structure, it is also applicable to securitizations secured by a few large loans. Structures featuring a larger number of loans to distinct borrowers, many of whom may be non-institutional in nature, pose additional credit considerations that are not addressed herein. (3)

This summary demonstrates that there are a lot of new characteristics for this asset-class that Kroll is trying to capture in its rating methodology. These include the hybrid nature of the security itself; the hybrid nature of the underlying collateral for the security; the innovative business model of institutional investors entering the single-family market in a big way; and the possible entry of new players in that market, such as non-institutional ones; and changes in the type of collateral underlying the securities.

The takeaway for readers: don’t mistake the apparent simplicity of a rating (AAA, Aaa) as a signal of the solidity of the reasoning that went into it. Ratings, particularly those for new types of securities, are constantly evolving. To think otherwise is to risk being left holding a bag filled with all of lemons that the market has to offer to unsuspecting investors.