Tag Archives: Treasury

Krimminger and Calabria on Conservatorships

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When the Federal Housing Finance Agency (“FHFA”) was appointed conservator for Fannie Mae and Freddie Mac, it was the first use of the conservatorship authority under the Housing and Economic Recovery Act of 2008 (“HERA”), but it was not without precedent. For decades, the Federal Deposit Insurance Corporation (“FDIC”) has successfully and fairly resolved more than a thousand failing banks and thrifts using the virtually identical sections of the Federal Deposit Insurance Act (“FDIA”).
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The predictability, fairness, and acceptance of this model led Congress to adopt it as the basis for authorizing the FHFA with conservatorship powers over Fannie Mae and Freddie Mac in HERA. Instead of following this precedent, however, FHFA and Treasury have radically departed from HERA and the principles underlying all other U.S. insolvency frameworks and sound international standards through a 2012 re-negotiation of the original conservatorship agreement.
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     This paper will:
  • Describe the historical precedent and resolution practice on which Congress based FHFA’s and Treasury’s statutory responsibilities over Fannie Mae and Freddie Mac;
  • Explain the statutory requirements, as well as the procedural and substantive protections, in place so that all stakeholders are treated fairly during the conservatorship;
  • Detail the important policy reasons that underlie these statutory provisions and the established practice in their application, and the role these policies play in a sound market economy; and
  •  Demonstrate that the conservatorships of Fannie Mae and Freddie Mac ignore that precedent and resolution practice, and do not comply with HERA. Among the Treasury and FHFA departures from HERA and established precedents are the following:
    • continuing the conservatorships for more than 6 years without any effort to comply with HERA’s requirements
      to “preserve and conserve” the assets and property of the Companies and return them to a “sound and solvent” condition or place them into receiverships;
    • rejecting any attempt to rebuild the capital of Fannie Mae or Freddie Mac so that they can return to “sound and solvent” condition by meeting regulatory capital and other requirements, and thereby placing all risk of future losses on taxpayers;
    • stripping all net value from Fannie Mae and Freddie Mac long after Treasury has been repaid when HERA, and precedent, limit this recovery to the funding actually provided;
    • ignoring HERA’s conservatorship requirements and transforming the purpose of the conservatorships from restoring or resolving the Companies into instruments of government housing policy and sources of revenue for
      Treasury;
    • repeatedly restructuring the terms of the initial assistance to further impair the financial interests of stakeholders contrary to HERA, fundamental principles of insolvency, and initial commitments by FHFA; and
    • disregarding HERA’s requirement to “maintain the corporation’s status as a private shareholder-owned company” and FHFA’s commitment to allow private investors to continue to benefit from the financial value of the company’s stock as determined by the market. (1-3, footnotes omitted)

I am intrigued by the recollections of these two former government officials who were involved in the drafting of HERA (much as I was by those contained in a related paper by Calabria). But I am not convinced that their version of events amounts to a legislative history of HERA, let alone one that should be given any kind of deference by decision-makers. The firmness of their opinions about the meaning of HERA is also in tension with the ambiguity of the text of the statute itself. The plaintiffs in the GSE conservatorship litigation will see this paper as a confirmation of their position. I do not think, however, that the judges hearing the cases will pay it much heed.

S&P’s Upbeat Outlook on Mortgage Market

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S&P posted U.S. RMBS Roundtable: Mortgage Origination And Securitization In The Post-Qualified Mortgage/Ability-To-Repay Market. The roundtable discussion offers views on many aspects of the 2015 mortgage market, but I found this passage to be particularly interesting:

Originators agreed loans that fall outside of the safe harbor by virtue of interest-only (IO) features have been and will continue to be attractive non-QM lending products. These loans have been originated post-crisis, and originators expect to continue lending to high-quality borrowers with substantial equity in their properties. There was general consensus that IO loans should not have been automatically excluded from QM treatment.

However, large bank depository lenders have shown a desire to originate and hold larger balance IO loans on their balance sheets rather than including them in securitizations. One participant from a major depository institution indicated that, given the increasing IO concentration on those institutions’ balance sheets, there may be a desire to securitize these loans upon meeting balance sheet thresholds. (1)

After Dodd-Frank, there was a lot of concern that the Qualified Mortgage and Ability-to-Repay rules would shut down the mortgage markets. It seems pretty clear to me that lenders are figuring out how to navigate both the plain-vanilla world of the Qualified Mortgage and the exotic world of the non-Qualified Mortgage, with its interest-only and other non-prime products. Lenders are still figuring out how far afield they can roam from a plain-vanilla product, but that is to be expected during a major transition such as the one from the pre- to the post-Dodd-Frank world.

Reiss on Drop in FHA Premium

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Law360 quoted me in FHA Premium Cut Sets Up Fight Over Future Of Housing (behind a paywall). It reads in part,

President Barack Obama’s plan to lower premiums on Federal Housing Administration insurance has rekindled a battle with Republicans over the rehabilitation of the recently bailed out government mortgage insurer and the government’s role in the U.S. housing market more broadly.

Obama on Thursday officially laid out a plan that would see the FHA charge borrowers half a percentage point less on mortgage insurance premiums beginning this month in a move to boost affordability for the low- and middle-income borrowers who traditionally rely on FHA-backed mortgages.

The announcement came as the FHA continues to recover from a post-financial crisis shortfall that saw the long-standing program receive a $1.7 billion bailout from the U.S. Department of the Treasury in 2013, the first time the FHA has needed federal support.

Obama’s move on mortgage insurance premiums could make the road to a secure FHA take that much longer, and, coupled with earlier policy changes by the Federal Housing Finance Agency on mortgages backed by Fannie Mae and Freddie Mac, set up a renewed fight with Republicans over government support for the housing market.

“What’s at stake is not just housing prices and mortgage rates,” Brooklyn Law School professor David Reiss said. “What’s implicit of all of this is: What’s the appropriate role of the government in the housing market?”

The president’s plan would see the FHA charge borrowers 0.85 percent annual premiums on their mortgage insurance, down from the 1.35 percent they currently pay. First-time homebuyers will see a $900 drop in their mortgage payments each year under the new policy, according to a fact sheet released Wednesday by the White House.

“It’ll help make owning a home more affordable for millions” around the country, Obama said in a speech in Phoenix on Thursday.

Housing analysts said that the move could help boost the housing market at the margins but would not entice a large number of first-time buyers to get into the housing market.

The lower mortgage insurance premium will prove to be “marginally beneficial for the average borrower, in our opinion, and consequently, we do not believe this news … is a catalyst for higher housing demand and higher earnings estimates,” Sterne Agee analyst Jay McCanless said in a note Thursday.

But what the rate cut does is put in clear relief Obama’s plan to boost the housing market and provide a strong government role in that key economic sector, even if it means potentially putting added pressure on the agencies that provide government assistance to the housing market. Those agencies include the FHA as well as the Federal Housing Finance Agency and the two failed mortgage giants over which it has authority, Fannie Mae and Freddie Mac.

“The tension is between financial responsibility and public policy about housing,” Reiss said.

In the FHA’s case, lowering the mortgage insurance premium is likely to increase the amount of time that the agency will need to get to a 2 percent capital level that is mandated by Congress.

An independent audit of the FHA’s finances released late last year found that the agency’s Mutual Mortgage Insurance Fund stood at a positive $4.8 billion as of the end of September after being as much as $16.3 billion in the hole in 2012.

Still, while the gain on the fund has been real, its capital ratio stood at only 0.41 percent in that period, far lower than the mandated 2 percent.

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Obama had backed congressional efforts to eliminate Fannie Mae and Freddie Mac and boost private capital in the mortgage market, but they failed amid disagreements between the Senate and House Republicans. The issue is now largely dormant.

That has left a vacuum for Obama to fill, Reiss said.

“Because Congress refused to act, Republicans are going to be stuck with a more activist government because they refused to come to the table and put together a proposal that can pass,” he said.

Reiss on Real Estate Cases To Watch In 2015

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Law360 quoted me in Real Estate Cases To Watch In 2015 (behind a paywall). It reads, in part,

As the real estate deals market has heated up, so have litigation dockets. And several cases with national or regional importance for developers and lenders on foreclosure practices, land use rights and housing finance reform are primed to see major developments in 2015, experts say.

A number of real estate cases wending their way through the court system – from state appeals courts to the U.S. Supreme Court – could affect how apartment owners, developers and lenders do business. And with the real estate market heating up, experts are also expecting a new wave of litigation to pop up in connection with an increasing pipeline of public-private partnership projects.

The cases are as varied as a high court suit that could throw open an avenue of Fair Housing Act litigation and a New Jersey matter that could give developers leverage to push forward on blocked projects. Here are a few cases and trends to watch in 2015:

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Hedge fund Fairholme Capital Management LLC’s challenge to the government’s directing all the profits from Fannie Mae and Freddie Mac toward the U.S. Department of the Treasury has been closely watched for more than a year, and it is expected to come to a head in 2015.

The company alleges the government acted unconstitutionally when it altered its bailout deal for the government-sponsored enterprises to keep the companies’ profits for itself.

“If the plaintiffs win, it could have a dramatic impact on how housing finance reform plays out,” said David Reiss, a professor at Brooklyn Law School. “And even if they don’t win, the case can have a negative impact on housing finance reform if it casts a cloud over the whole project.”

Shareholders lost a related case in the D.C. district court, “but if they win the Fairholme case, things will get complicated,” Reiss said.

The case is Fairholme Funds Inc. v. U.S., case number 13-cv-00465, in the U.S. Court of Federal Claims.

GSE Shareholder Litigation Issue

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The NYU Journal of Law & Business has posted a special issue devoted to the GSE shareholder litigation. Here are the links for the the individual articles:

The Government Takeover of Fannie Mae and Freddie Mac: Upending Capital Markets with Lax Business and Constitutional Standards
Richard A. Epstein
The Fannie and Freddie Bailouts Through the Corporate Lens
Adam B. Badawi & Anthony J. Casey
An Overview of the Fannie and Freddie Conservatorship Litigation
Davis Reiss
Back to the Future: Returning to Private-Sector Residential Mortgage Finance
Lawrence J. White
Reforming the National Housing Finance System: What’s at Risk for the Multifamily Rental Market if Fannie Mae and Freddie Mac Go Away?
Mark Willis & Andrew Neidhardt

I have blogged about drafts of some of the articles here (Epstein), here (Badawi and Casey) and here (my contribution) and I may very well blog about the rest of them over the next few weeks. Given the nature of legal scholarship, these articles were written well before many of this year’s developments in the GSE shareholder litigations (such as Judge Lamberth’s ruling in the District Court for the District of Columbia case).  Nonetheless, these articles have a lot to offer in terms of understanding the broader issues at stake in the ongoing litigation (the first three articles) and in terms of reform efforts going forward (the last two articles).

Fannie and Freddie Begin a New Stage

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The Federal Housing Finance Agency has ordered Fannie and Freddie to begin making contributions to the Housing Trust Fund and to the Capital Magnet Fund.  These two funds were created pursuant to the Housing and Economic Recovery Act of 2008, the same statute that authorized placing the two companies in conservatorship. In 2008, FHFA Acting Director DeMarco suspended payments into the two funds because the two companies were being bailed out by the federal government. Now that the two companies are on firmer financial footing, the FHFA has lifted the suspension. The suspension will go back into effect for a company if it has to make a draw from Treasury under the Senior Preferred Stock Purchase Agreement, that is if the company does not have enough excess monies to make the payments into the two funds from its own income.

This action is not so surprising, given Watt’s past statements. It does, however, have some interesting implications. In terms of the GSE shareholder litigation, these allocations reduce the enterprises’ capital by a not insignificant amount; if shareholders were to win one of their lawsuits, monies placed in these two funds would be unavailable to them. In terms of housing finance reform, this action signals that the companies have moved beyond their crisis stage into a more stable one. It also emphasizes that the FHFA can take big steps on its own when it comes to housing finance reform, notwithstanding Congressional gridlock. All in all, it feels like the beginning of a new stage in the lives of the two companies.

The FHFA has issued an Interim Final Rule and Request for Comments relating to the payments into the two funds. The rule “implements a statutory prohibition against the Enterprises passing the cost of such allocations through to the originators of loans they purchase or securitize.” (1) Comments are due 30 days after the interim final rule is published in the Federal Register.

Reiss on Shakespearean GSE Litigation

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Fundweb quoted me in Stateside: My Kingdom for a House. It reads in part,

History repeats itself. In 1483, Richard III seized the British crown from his 13-year-old nephew on a trumped up legal sophistry.  One justification was to prevent a return to the chaos of the War of the Roses, considered likely to resume under a child king. (Many historians believe he subsequently murdered those princes in the tower to dispense with future claims.)

Five centuries later, the issue of confiscation returns in the form of US government actions taken to stabilise the financial system during the 2008 credit crisis.  The usurpation argument repeats that the end justifies the means and the rule of law may be subverted in perceived emergencies for the common good. Recent legal cases are challenging that principle, with momentous long- term consequences for the nation.

Specifically, in 2008, Congress enacted the Housing Economic and Recovery Act, which authorised loans to mortgage agencies Fannie Mae and Freddie Mac known as government-sponsored entities. The HERA law placed the GSEs in a conservatorship, giving the US government senior preferred shares in the companies, which paid the government a 10 per cent dividend.

Eventually, the GSEs became immensely profitable again, having now repaid $30bn more to the government than the original loan. In 2012, the conservator passed a third amendment, which transformed the 10 per cent preferred dividend to a sweep of all profits, forever.

Richard Bove, vice-president equity research at Rafferty Capital Markets, responds: ”If the government has the right to override any contract and can appropriate private property for itself, then contracts mean nothing in the US and the government is like Richard III.”

Politics of populism
Ultimately, the government may determine whether the GSEs survive or in what guise or how their profits are distributed.

“Politicians are carrying out what people want them to do.  The public and the media maintain that if the bankers are harming society and the economy, there is no limitation on what the government can do,” says Bove. But beware. Investor confidence further erodes each time the government steps in to act unilaterally in the name of crisis control. The determinant is whether or not the country needs the GSEs to continue to underwrite mortgages and the answer is probably yes. Without them, there will be no one to under-write 30-year mortgages, “the monthly cost of owning a home will go up, prices will go down and it will kill housing in the US,” Bove insists.

Mel Watts, who was appointed this year as a new conservator, may represent a new direction for reshaping the GSEs. His recent speeches suggest he may be planning to merge the two agencies and liberate them from conservatorship status.

David Reiss, professor at Brooklyn Law School, points out another drawback to leaving the GSEs in limbo for six years. Executives, employees and others are now running for the exits, with turnover at the top. The agencies back 60 per cent of residential US mortgages but no longer know who they are. “It’s not healthy for homeowners or taxpayers,” says Reiss.

Investment War of the Roses
A number of hedge fund investors have rebelled, challenging the conservator’s behaviour. Marquee names include Perry Capital, Fairholme Funds and Pershing Square Capital Management. Their claims generally derive from assertions that the conservator illegally expropriated shareholder profits. The plaintiff hedge funds represent a motley crew, some of whom bought the stock after 2009, knowing they were picking up lottery tickets, and others well predating the conservatorship. From the sidelines, smaller investors watched keenly and joined the big boys’ ranks.

“People bought the stock only knowing that Icahn, Berkowitz and Ackmann had positions, so they followed like lemmings,” says Bove. To compound the confusion, most conventional wisdom from commentators lined up on one side. Many were openly remunerated by the shareholders, like New York University’s Richard Epstein.

Reiss adds that, “with no public speakers of equivalent prestige on the other side, it seemed inconceivable the investors might lose, which was a perfect set up for falling hard”.

Indeed they fell, with the recent ruling by Judge Royce Lamberth in the Perry hedge fund case.  The court dismissed the suit with complex arguments but one theme undergirded the judge’s ruling: the government had acted forcefully in a financial emergency, authorised by Congress, which he hesitated to unwind.