Fannie Mae and Freddie Mac Living Wills
Fannie Mae and Freddie Mac control the residential mortgage market as the two largest buyers of mortgages in the US. Each holds a portfolio of more than $2 trillion and buys around $50 billion more every month. Both effectively went bankrupt in 2008 in the prior housing crisis. Because they operated as GSEs (Government Sponsored Enterprises), Fannie Mae and Freddie Mac had access to lines of credit at the US Treasury to avoid a total shutdown. However, the US Treasury took control through conservatorship after advancing more than $100 billion to prop them up. Recently new rules took the first steps towards living wills.
Fannie Mae and Freddie Mac were strongly encouraged by the federal government to expand the amount of risky mortgages to sub-prime buyers in the late 1990s and early 2000s as part of an “equity” push. Both were stuffed with ex-Clinton administration officials with millions of dollars in salaries and incentives geared towards loan volumes and profitability. The Bush administration went along with the push post 9/11 to re-invigorate the economy through stimulating the housing sector. As a result, when 2008 and 2009 rolled around, the GSE portfolios housed hundreds of billions of dollars in bad loans.
Fannie and Freddie Influence
But the influence of the GSEs goes further than their own respective portfolios. As the de facto leaders in the mortgage sector, Fannie and Freddie effectively set benchmarks for loans standards, loan rates, and loan underwriting. This applied prior to 2008 and continues today. Any private company making loans follows the path set by the GSEs or risks getting no business.
Prior to the 2008 crisis, the GSEs competed away prudent underwriting standards. Many lenders then followed Fannie and Freddie standards and guidance in lowering standards. They generated an enormous amount of loans to borrowers who should never have had a mortgage. But these lenders were able to sell the loans to Fannie and Freddie and book eye-popping profits. Who would be surprised that when the government or government sponsored entities hand out free money, a long line forms quickly! Think Countrywide Home Loans. Think of the movie The Big Short.
Conservatorship
After booking short term profits at the expense of long term profitability and prudent lending, Fannie and Freddie imploded in 2008 along with many other lenders. By taking on stupid risks, these two entities were at the forefront of the crisis as a result of many factors. But one of the biggest factors was political influence peddling. Once the GSEs fell into conservatorship, their preferred stock become worthless. Many, many banks had been encourages by state and federal regulators to buy Fannie Mae and Freddie Mac preferred stock as “safe” investments for their investment portfolios. When that preferred stock became worthless, the same regulators required that the banks write them off. With the write-offs, a number of banks, large and small, also quickly imploded. Think IndyMac and others.
During the past 12 years (12 YEARS!) of conservatorship, all profits have been effectively swept up by the US Treasury. The US Treasury controls Fannie and Freddie in conservatorship through the FHFA (Federal Housing Finance Agency). Until Mark Calabria was appointed FHFA Director by the prior administration, the bankrupt entities continued as if nothing had change in their operations. No plan to exit conservatorship was forthcoming. Executives continue to draw large salaries.
Living Wills Rule Published
Director Calabria put the GSEs on a path to slowly diminish their role and find a path to exit conservatorship. The rules strive to lower the enormous risk and influence of the GSEs. A number of steps previously discussed in My Winning Mortgage evidence that shift starting. On May 13, Director Calabria wrote an op-ed published in the Wall Street Journal defending the final ‘living wills’ rule published in the Federal Register on May 4. The shifts came about mainly starting in January. This January change put the cap on financing sales of second homes and investor properties. The changes also limit purchases in the cash window, capped multifamily loans, and limit sales that include a combination of risky borrower attributes.
Other actions began a little earlier. Following the CARES Act forbearance requirement new charges included forbearance re-finance 5.0%/7.0% risk fees and a .50% adverse market refinance fee. [Update: As of July 16, 2021, the extra .50% charge to refinance has been eliminated.]
Will the new living wills move towards an exit from government control? Various caps noted above seem intended to start reducing the volume of mortgages controlled by the GSEs and start shrinking their portfolios. This would reduce their influence and return much of it back to the private sector more free from political influence meddling. Good or bad?
Changes Referenced
New GSE guideline updates to Fannie and Freddie forces them to cap the amount of second home and investor properties delivered at 7%. This means a meaningful amount of supply of lending will have to come from the private industry. The industry should trust a person by what they say. Director Calabria has said for many years that these companies are too big. They crowd out private capital. And they pose way too much taxpayer risk which needs to be dealt with.
The FHFA Director has sole authority, requiring no approval from either Congress or Treasury, to put the GSEs into receivership or into successor entities. In fact, Calabria stated this himself in an interview in May of 2020. In this interview he stated it clearly, “Endless limbo is not an option under statute. FHFA has the power and the responsibility to end the conservatorships of the GSEs. Congress authorized FHFA to do this by either of two methods. FHFA may reconstitute the GSEs into a successor entity or entities in a position of financial stability and shareholder control. Or FHFA may place them in receivership.
Living Wills Details
The ‘living wills’ will guide the liquidation or resolution of the GSEs if risks and obligations repeat a 2008 type fiasco.
FHFA also can appoint itself as conservator or receiver of an Enterprise under statutory guidelines. When appointed receiver of an Enterprise, FHFA must establish a limited-life regulated entity (LLRE). The LLRE will succeed immediately to the Enterprise’s federal charter. Thereafter, the LLRE will operate subject to the Enterprise’s authorities and duties.
In other words, raise capital, go public, or close down under a set timeline.
2. The GSEs raise enough capital to avoid receivership in the first place.
The rule prohibits each Enterprise from assuming that any extraordinary support from the government would continue. That rule prevents the Enterprises from assuming support to prevent danger of default or default. FHFA will require the Enterprises to develop ‘credible’ plans to facilitate their ‘rapid and orderly resolution’ by FHFA as receiver.
3. The GSEs need to scale down and return to their core missions.
The rule states that the Enterprise resolution planning process will begin with identification of an Enterprise’s ‘core business lines’ (CBLs). Core Business Lines represent those business lines of the Enterprise that plausibly would continue to operate in the LLRE.”
Do some unique programs like early funding, cash window, expanded products, and other functions, fit the definition of CBL?
Additionally, the rule states FHFA agrees Enterprises are not responsible for continuation in business of third parties that provide services.
Director Calabria’s speech at the Brookings Institute suggested the timeline for living wills could be as soon as six months. The FHFA clearly believes that the private sector can pick up more of the GSE space and lessen taxpayer risk.