Tag Archives: Trump Administration

What Happens if Fannie and Freddie Go Private?

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I was quoted in Fintech Nexus’ Home Invasion: What Happens if Fannie and Freddie Go Private. It reads, in part,

The Trump Administration has telegraphed significant changes to GSE mortgage lenders — with massive implications for the industry

Since his swearing in on March 14 as the fifth Director of the Federal Housing Finance Agency (FHFA), construction mogul William J. Pulte has executed major policy and personnel changes. Among other moves, Pulte has named himself board chair of the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac, removed 14 of the GSEs’ 25 sitting board members, fired most of the companies’ audit boards, generally slashed headcount, and rescinded several Biden-era oversight-related advisory bulletins.

According to Professor David Reiss of Cornell Law School, a scholar of real estate finance and housing policy, Pulte’s simultaneous leadership of the FHFA in addition to roles at the GSEs, which have been under federal conservatorship since the 2008 financial crisis, is not normal.

“The whole point of regulation is you have somebody who’s overseeing an industry,” he told Fintech Nexus. “This is like the left hand [knowing] what the right hand is doing: You’re overseeing yourself, so it’s … kind of inconsistent with the notion of a supervisory regulator.”

Fintech Nexus contacted the FHFA, requesting that it comment on the impetus behind Pulte’s simultaneous self-appointments to Fannie and Freddie. The FHFA did not respond.

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CAPITAL IDEAS

One idea percolating is for the Trump Administration to use Fannie and Freddie as a pool of capital to inject into a sovereign wealth fund. An op-ed in the Financial Times by Stifel CEO Ronald Kruszewski suggested this reconfiguration could provide “continued government backing,” “stabilize investor confidence,” and “pave the way for a $1 trillion sovereign wealth fund by 2040.”

However, in a letter to the editor in the Financial Times, Dini Ajmani, Former Deputy Assistant Secretary of the US Treasury, suggested the idea would fail, as any privatization of the GSEs would require proper capitalization, taxpayer compensation, and adequate confidence of securities investors.

“I believe the difficulty in meeting all three conditions is why [the] status quo has persisted,” Ajmani told Fintech Nexus. “To build capital, Fannie/Freddie must retain earnings, which means the taxpayer is not compensated. If the taxpayer is compensated through dividend payments, private capital will be uninterested because the agencies will be undercapitalized.”

To this end, FHFA Director Pulte may continue to atrophy many forms of GSE oversight as a way to prime the pump: Pre-empting congressional activity by deregulating Fannie and Freddie can accelerate their transition toward open-market frameworks.

The Trump Administration may see it as its only viable short-term  avenue, as many members of Congress are uninterested in bringing Fannie and Freddie out of conservatorship; Senator Elizabeth Warren (D-MA), member of the Senate Committee on Banking, Housing, and Urban Affairs, called the move “Great for billionaires, terrible for hardworking people.”

Should the Trump Administration succeed in its quest, we may see states attempting to fill in the gaps on regulatory accountability, rhyming with blue-state attorneys-general’s litigiousness in the wake of the Consumer Financial Protection Bureau’s de-clawing, though this is unlikely.

“State regulators do not generally play a role similar to the two companies (except to some small extent state Housing Finance Agencies),” Reiss of Cornell Law School said. “I could imagine state agencies trying to increase consumer protection for mortgage borrowers, if the federal regulatory environment changes, but we would have to see how that plays out to understand how the states would respond.”

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.

The Brewing Constitutional Crisis

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Benjamin Franklin bust by Jean-Antoine Houdon

437 law professors (myself included) from across the country have signed the following statement to call attention to the constitutional crisis that the nation is now facing.

A CALL TO URGENCY

The opening weeks of the second Trump administration convince us, as law professors who have spent years studying the American legal system, that we are beginning to see unfold the gravest threat to the rule of law and its constituent principles – the separation of governmental powers, the independence of prosecutorial authority, the inviolability of human rights, the transparency of government action, and the sanctity of constitutional accountability itself – ever presented in our lifetimes. The president’s and his associates’ actions, and threats of action, profoundly undermine the bedrock principle of our federal government system – that the Chief Executive and his agents are constrained by the United States Constitution. The fundamental guardrails of our constitutional democracy itself are threatened and notably battered. They are, as we write, at risk of complete collapse.

We recall that Benjamin Franklin warned, when asked by Elizabeth Willing Powell whether he and his colleagues had delivered “a republic or a monarchy,” that we have “a republic” but only “if you can keep it.” We hope that all Americans, and especially all lawyers, will recognize the gravity of this situation and will be prepared to answer that challenge with the urgency required in the days, weeks, and months ahead.

You can find the current list of signatories here.

Hope for GSE Shareholders

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Judge Lamberth issued an opinion in Fairholme Funds, Inc. v. FHFA (Civ. No.13-1439) (Sept. 28, 2018) that gives some hope to the private shareholders of Fannie Mae and Freddie Mac. These shareholders have been on the losing end of nearly every case brought against the government relating to its handling of the conservatorships of the two companies.  Readers of this blog know that I have long been a skeptic of the shareholders’ claims because of the broad powers granted the government by the Housing and Economic Recovery Act of 2008, passed during the height of the financial crisis, as well as the highly regulated environment in which the two companies operate. This highly regulated environment means that GSE profits are driven by regulatory decisions much more than those of other financial institutions. As such, Fannie and Freddie live and die by the sword of government intervention in the mortgage market.

Judge Lamberth had dismissed the plaintiffs’ claims in their entirety, but was reversed in part on appeal. In this case, he revisits the issues arising from the reversal of his earlier dismissal. Once again, Judge Lamberth dismisses a number of the plaintiffs’ claims, but he finds that that their claim that the government breached the duty of good faith survives.

The opinion gives a road map that shareholders can follow to success. The judge identifies allegations that, if true, would be a sufficient factual basis for a holding that the government breached the implied covenant of good faith and fair dealing. It is plausible that the preponderance of proof may support these allegations. Some evidence has already come to light that indicates that at least some government actors had good reason to believe that Fannie and Freddie were on the cusp of sustained profitability when the government implemented the net worth sweep. The net worth sweep had redirected the net profits of the two companies to the U.S. Treasury.

Judge Lamberth highlights some of aspects of the plaintiffs’ argument that he found compelling at the motion to dismiss phase of this litigation. First, he notes that absence of “any increased funding commitment” is atypical when senior shareholders receive “enhanced disbursement rights,” as was the case when the government implemented the net worth sweep. (21) He also states that the plaintiffs would not have expected that the GSEs would have extinguished “the possibility of dividends arbitrarily or unreasonably.” (22)

While this opinion is good news for the plaintiffs, it is still unclear what their endgame would be if they were to get a final judgment that the net worth sweep was invalid. Depending on the outcome of regulatory and legislative debates about the future of the two companies, the win may be a pyrrhic one. Time will tell. In the interim, expect more discovery battles, motions for summary judgment and even a trial in this case. So, while this opinion gives shareholders some hope of ultimate success, and perhaps some leverage in political and regulatory debates, I do not see it as a game changer in itself.

In terms of the bigger picture, there are a lot of changes on the horizon regarding the future of the housing finance system. The midterm elections; Hensarling and Corker’s departure from Congress; and the Trump Administration’s priorities are all bigger drivers of the housing finance reform train, at least for now.

Fight Over The Community Reinvestment Act

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Bloomberg BNA quoted me in Community Investment Revamp for Banks Likely To Spark Fight (behind a paywall). It opens,

Community groups and banks agree that the Community Reinvestment Act needs an update, but with regulators beginning an ambitious overhaul of the 1977 law there is little agreement on how that update should look.

The Trump administration has been targeting the CRA — which measures how well banks lend to low- to middle-income areas — for a rewrite since last June. Comptroller of the Currency Joseph Otting said March 28 that the first draft would be coming in early April.

Otting set out some broad ideas that his agency, the Office of the Comptroller of the Currency, and the other regulators that oversee the CRA will present to the public. The Federal Reserve and the Federal Deposit Insurance Corporation also have responsibility for measuring banks’ compliance with the law, and the OCC says that it hopes the two agencies will sign on to the coming advanced notice of proposed rulemaking.

Banking industry experts and community groups all said that the broad strokes of the regulators’ plan sound promising, but few expect that comity to continue when the details come more into view.

“I think you can assume that everybody is not going to be happy,” Laurence Platt, a partner at Mayer Brown LLP, told Bloomberg Law.

The CRA’s Present

The Trump administration first put the CRA in its sights in a June 2017 Treasury Department report outlining its broader views on altering the rules banks operate under.

The law calls for the OCC, the Fed and the FDIC to periodically measure how much lending the banks they oversee do inside geographical assessment areas based on their branch and ATM locations. If banks are found not to do enough of such lending, regulators can stop some business activities or hold up branch expansions and mergers. But it hasn’t been updated for nearly two decades.

The Treasury Department followed up the June 2017 statement on the CRA with an April 3 report outlining its thinking on ways to modernize the law. The report largely aligns with the path laid out by Otting.

“Our recommendations will improve the effectiveness of CRA by enhancing the assessment and examination process, enhancing the ability of banks to deliver services in the communities they serve while considering technological advances in the financial industry,” Treasury Secretary Steven Mnuchin said in a statement accompanying the report.

Changes to the Community Reinvestment Act have already begun, with the OCC under former acting Comptroller of the Currency Keith Noreika in October declaring that the OCC examiners would no longer include enforcement actions that are not linked to a bank’s CRA compliance in their rating.

That change was minor, and affected only one of the three regulators responsible for the CRA. Otting on March 28 laid out a host of other changes likely coming in a new proposal.

The CRA’s Future?

The broad outline Otting provided on March 28 largely highlights the areas in the CRA that community activists and banks have said need to be addressed.

Among the changes Otting said will be put out for comment include expanding the types of lending that would be included in calculations of banks’ CRA compliance to encompass small business, student lending and other money going into a community.

“I think there’s a sense that community-based activities, beyond individual lending, should be given more credit, such as small business loans and infrastructure loans,” Mayer Brown’s Platt said.

Other areas that are going to be addressed in the proposal will touch on the way CRA information is calculated and reported to the public. Currently, banks are examined for compliance every three to five years, and the banks’ reviews take an additional year.

Overall, Otting said the changes would be significant.

“This is monumental change for America,” Otting said in an appearance March 28 at the Operation Hope Global Forum in Atlanta.

The changes Otting discussed all sound promising, but they are vague. So fights are likely to emerge when the details come out.

“The comments that were made were vague enough to give you both concern and possible joy,” Taylor said.

One other aspect of the CRA that is ripe for reform is the geographic assessment areas regulators use to evaluate banks’ lending efforts. Otting and other regulators have yet to specifically outline their ideas for making changes to that, but both the comptroller and Fed Vice Chair for Supervision Randal Quarles have discussed including mobile banking, online lending, and other financial technology tools into their reviews.

How they elect to make that change is likely to be contentious as well.

“If the assessment area is poorly defined, then the CRA will lose its teeth and that’s going to drive CRA policy for a long time to come,” said David Reiss, a professor at Brooklyn Law School.

“Modernizing” the Community Reinvestment Act

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President Carter signs the Housing and Community Development Act of 1977, which contains the Community Reinvestment Act

The Trump Administration has been signaling its intent to do a makeover of the Community Reinvestment Act of 1977 (CRA) for quite a while, describing it as a much needed update.  Last June, Treasury stated in its Banks and Credit Unions report (one of a series of reports on A Financial System That Creates Economic Opportunities which I discuss here),

The CRA statute is in need of modernization, regulatory oversight must be harmonized, and greater clarity in remediating deficiencies is called for. It is very important to better align the benefits arising from banks’ CRA investments with the interest and needs of the communities that they serve and to improve the current supervisory and regulatory framework for CRA. . . . Aligning the regulatory oversight of CRA activities with a heightened focus on community investments is a high priority for the Secretary. (9)

Well, the modernization effort has now taken off with a Treasury Memorandum for The Office of The Comptroller of the Currency, The Board of Governors of The Federal Reserve System, The Federal Deposit Insurance Corporation. By way of background, the memorandum notes that

The Community Reinvestment Act (CRA) of 1977 was enacted to encourage banks to meet the credit and deposit needs of communities that they serve, including low- and moderate-income (LMI) communities, consistent with safe and sound operations. Banks are periodically assigned a CRA rating by one of the primary regulators – the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), and the Federal Deposit Insurance Corporation (FDIC), collectively the CRA regulators – based on the bank’s performance under the appropriate CRA tests or approved Strategic Plan. CRA was enacted in response to concerns about disinvestment and redlining as well as a desire to have financial institutions “play the leading role” in providing the “capital required for local housing and economic development needs.”

The U.S. banking industry has experienced substantial organizational and technological changes; however, the regulatory and performance expectations under CRA have not kept pace. Interstate banking, mortgage securitization, and internet and mobile banking are just a few of the major changes that have come about in the past four decades. In this evolving banking environment, changes should be made to the administration of CRA in order for it to achieve its intended purpose. (1, footnotes omitted)

The bank that Treasury Secretary Mnuchin used to head up, OneWest, had its own run-ins with CRA compliance. As a result, we should look carefully at how Treasury seeks to “modernize” the CRA. The Treasury memo has four recommendations:

  • Assessment Areas. The concept of assessment areas originated within the banking environment that existed in 1977, when there was no interstate banking and deposits almost always came from the community surrounding a branch. Treasury offers recommendations for updating the definitions of geographic assessment areas to reflect the changing nature of banking arising from changing technology, customer behavior, and other factors.
  • Examination Clarity and Flexibility. Both banks and communities would benefit from additional flexibility in the CRA performance evaluation process, including increasing clarity in the examination guidance. Treasury recommends improvements that could be made to CRA performance evaluation criteria that would increase the transparency and effectiveness of CRA rating determinations.
  • Examination Process. Certain aspects of the examination process need to be addressed in order to improve the timeliness of performance evaluations and to allow banks to be more accountable in planning their CRA activity. Treasury recommends improvements that could be made with respect to the timing of CRA examinations and issuance of performance evaluations, and to the consistent use of census data throughout an assessment period.
  • Performance. The purpose of CRA is to encourage banks to meet the credit and deposit needs of their entire community. The law does not have explicit penalties for nonperformance. However, performance is incentivized as regulators must consider CRA ratings as a part of various bank application processes and performance evaluation reports are made available to the public. Treasury offers recommendations as to how the current regulatory approach to downgrades for violations of consumer protection laws and various applications from banks with less than a Satisfactory rating could be improved to incentivize CRA performance. (2, footnotes omitted)

While there is lot to chew on here, I think a key issue will be the scope of the Assessment Areas. As banks move from straight ‘bricks and mortar’ to ‘bricks and clicks’ or even to pure clicks, it is harder to identify the community each bank serves.

While the memo does not offer a new definition for Assessment Areas, one could imagine alternative definitions that are either loose or stringent as far as CRA compliance is concerned. Because the CRA was intended to ensure that low and moderate-income communities had access to mortgage credit after years of redlining, any new definition of Assessment Areas should be designed to support that goal. We’ll have to see how the Trump Administration proceeds in this regard, but given its attitudes toward fair housing enforcement, I am not hopeful that the Administration will take the CRA’s goals seriously.

The Regulation of Residential Real Estate Finance Under Trump

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I published a short article in the American College of Real Estate Lawyers (ACREL)  (ACREL) News & Notes, The Regulation of Residential Real Estate Finance Under Trump. The abstract reads,

Reducing Regulation and Controlling Regulatory Costs was one of President Trump’s first Executive Orders. He signed it on January 30, 2017, just days after his inauguration. It states that it “is the policy of the executive branch to be prudent and financially responsible in the expenditure of funds, from both public and private sources. . . . [I]t is essential to manage the costs associated with the governmental imposition of private expenditures required to comply with Federal regulations.” The Reducing Regulation Executive Order outlined a broad deregulatory agenda, but was short on details other than the requirement that every new regulation be accompanied by the elimination of two existing ones.

A few days later, Trump issued another Executive Order that was focused on financial services regulation in particular, Core Principles for Regulating the United States Financial System. Pursuant to this second Executive Order, the Trump Administration’s first core principle for financial services regulation is to “empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth.” The Core Principles Executive Order was also short on details.

Since Trump signed these two broad Executive Orders, the Trump Administration has been issuing a series of reports that fill in many of the details for financial institutions. The Department of Treasury has issued three of four reports that are collectively titled A Financial System That Creates Economic Opportunities that are directly responsive to the Core Principles Executive Order. While these documents cover a broad of topics, they offer a glimpse into how the Administration intends to regulate or more properly, deregulate, residential real estate finance in particular.

This is a shorter version of The Trump Administration And Residential Real Estate Finance, published earlier this year in the Westlaw Journal: Derivatives.