GSE Investors’ Hidden Win

Judge Brown

The big news yesterday was that the US Court of Appeals for the DC Circuit ruled in the main for the federal government in Perry Capital v. Mnuchin, one of the major cases that investors brought against the federal government over the terms of the Fannie and Freddie conservatorships.

In a measured and carefully reasoned opinion, the court rejected most but not all of the investors’ claims.  The reasoning was consistent with my own reading of the broad conservatorship provisions of the Housing and Economic Recover Act of 2008 (HERA).

Judge Brown’s dissent, however, reveals that the investors have crafted an alternative narrative that at least one judge finds compelling. This means that there is going to be some serious drama when this case ultimately wends its way to the Supreme Court. And there is some reason to believe that a Justice Gorsuch might be sympathetic to this narrative of government overreach.

Judge Brown’s opinion indicts many aspects of federal housing finance policy, broadly condemning it in the opening paragraph:

One critic has called it “wrecking-ball benevolence,” James Bovard, Editorial, Nothing Down: The Bush Administration’s Wrecking-Ball Benevolence, BARRONS, Aug. 23, 2004, http://tinyurl.com/Barrons-Bovard; while another, dismissing the compassionate rhetoric, dubs it “crony capitalism,” Gerald P. O’Driscoll, Jr., Commentary, Fannie/Freddie Bailout Baloney, CATO INST., http://tinyurl.com/Cato-O-Driscoll (last visited Feb. 13, 2017). But whether the road was paved with good intentions or greased by greed and indifference, affordable housing turned out to be the path to perdition for the U.S. mortgage market. And, because of the dominance of two so-called Government Sponsored Entities (“GSE”s)—the Federal National Mortgage Association (“Fannie Mae” or “Fannie”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “Freddie,” collectively with Fannie Mae, the “Companies”)—the trouble that began in the subprime mortgage market metastasized until it began to affect most debt markets, both domestic and international. (dissent at 1)

While acknowledging that the Fannie/Freddie crisis might justify “extraordinary actions by Congress,” Judge Brown states that

even in a time of exigency, a nation governed by the rule of law cannot transfer broad and unreviewable power to a government entity to do whatsoever it wishes with the assets of these Companies. Moreover, to remain within constitutional parameters, even a less-sweeping delegation of authority would require an explicit and comprehensive framework. See Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457, 468 (2001) (“Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.”) Here, Congress did not endow FHFA with unlimited authority to pursue its own ends; rather, it seized upon the statutory text that had governed the FDIC for decades and adapted it ever so slightly to confront the new challenge posed by Fannie and Freddie.

*     *     *

[Congress] chose a well-understood and clearly-defined statutory framework—one that drew upon the common law to clearly delineate the outer boundaries of the Agency’s conservator or, alternatively, receiver powers. FHFA pole vaulted over those boundaries, disregarding the plain text of its authorizing statute and engaging in ultra vires conduct. Even now, FHFA continues to insist its authority is entirely without limit and argues for a complete ouster of federal courts’ power to grant injunctive relief to redress any action it takes while purporting to serve in the conservator role. See FHFA Br. 21  (2-3)

What amazes me about this dissent is how it adopts the decidedly non-mainstream history of the financial crisis that has been promoted by the American Enterprise Institute’s Peter Wallison.  It also takes its legislative history from an unpublished Cato Institute paper by Vice-President Pence’s newly selected chief economist, Mark Calabria and a co-author.  There is nothing wrong with a judge giving some context to an opinion, but it is of note when it seems as one-sided as this. The bottom line though is that this narrative clearly has some legs so we should not think that this case has played itself out, just because of this decision.

The Duty to Serve Underserved Markets

Riverview Homes Inc

The Federal Housing Finance Agency has issued a Notice of Proposed Rulemaking and Request for Comments regarding Enterprise Duty to Serve Underserved Markets.  The “Enterprises” are Fannie and Freddie and this duty to serve is a highly contested one, with some on the right blaming it for pretty much the whole financial crisis and some on the left arguing that it is the key rationale for keeping the government involved in the mortgage market.

This debate is complicated by the fact that Fannie and Freddie are in conservatorship for the foreseeable future. Whatever one believes the duty to serve should be for the two companies if they were operating independently, one might have a different view of it while they are operating as government instrumentalities.

The Notice provides the following summary:

The Housing and Economic Recovery Act of 2008 (HERA) amended the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (Safety and Soundness Act) to establish a duty for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the Enterprises) to serve three specified underserved markets—manufactured housing, affordable housing preservation, and rural markets—to increase the liquidity of mortgage investments and improve the distribution of investment capital available for mortgage financing for very low-, low-, and moderate-income families in those markets. The Federal Housing Finance Agency (FHFA) is issuing and seeking comments on a proposed rule that would provide Duty to Serve credit for eligible Enterprise activities that facilitate a secondary market for mortgages related to: Manufactured homes titled as real property; blanket loans for certain categories of manufactured housing communities; preserving the affordability of housing for renters and homebuyers; and housing in rural markets. The proposed rule would establish a method for evaluating and rating the Enterprises’ compliance with the Duty to Serve each underserved market.

Written comments must be received on or before March 17, 2016, so get crackin’.

Reiss on Marketplace: Cash Cows to Slaughter

I was interviewed on Marketplace for its story, Fannie and Freddie: Cash Cows Avoid The Slaughter? (sound file) The text of the story reads

We are making money – the tax payer, that is – on Fannie and Freddie Mac.

When Freddie Mac hands the treasury a $10.4 billion dividend next month, tax payers will have received more money in interest than was put in. (Technically the two institutions still owe the principal on the loan that bailed them out, but the interest they’re paying will shortly exceed that amount).

But.

There always is a but with these things.

Making money for the tax payer isn’t good if you ask those who want reform.

Back during the financial crisis, conservatives and liberals disagreed over whether Freddie and Fannie were a victim of or a cause of the housing collapse, but they agreed that the institutions needed reform. The profits are throwing a wrinkle into this debate.

“As long as Fannie and Freddie continue to pay substantial amounts of money to the government, they are looked at by some people in Congress as a great source of revenue that reduces the deficit,” explains Peter Wallison with the American Enterprise Institute. His concern – shared by reformers on both sides of the political spectrum – is that if Fannie and Freddie become cash cows, congress won’t want to touch them.

David Reiss, professor of law at the Brooklyn Law School, agrees. He says the financial crisis wasn’t a one time problem.

“We should think of it as that we dodged a bullet. There’s fundamental problems with the Fannie and Freddie business model which rests on this notion of privatizing profits and socializing losses.”

Freddie and Fannie buy mortgages from lenders, and then bundle them into “mortgage backed securities” that can be sold to investors. It’s useful because it converted illiquid mortgage loans into liquid securities. In plain English, it means a bank or investor who made a mortgage loan to someone didn’t have to wait around for 30 years to be paid back. They could sell their stake in the mortgage to Fannie or Freddie, move along, and go invest in other things. This helped more people get mortgages.

One concern was that Fannie and Freddie were simply too big and too concentrated. Another concern was that the federal government implicitly guaranteed investments in Freddie and Fannie, and that encouraged people to make home loans that were too risky.

Even without the complication of profits, the debate over how to reform Fannie and Freddie is at a stand still.

House Republicans don’t want the government involved at all, they want an efficient market. The Senate wants the government to be involved a little bit, essentially to promote housing.

“What I see,” says David Reiss, “is nothing really happening, and us being a holding pattern for a long time.”

It’s possible that reform-minded politicians will compromise before they lose their chance. Also possible they won’t.