As capital dwindles, trouble looms for Fannie Mae and Freddie Mac
This Op-Ed appeared in The Hill on June 7, 2017.
BY GLEN CORSO, SCOTT OLSON AND HILARY SHELTON, OPINION CONTRIBUTORS
Federal Housing Finance Agency (FHFA) Director Mel Watt recently delivered two direct messages to Congress: First, it is dangerous to operate the two institutions that undergird half of the U.S. mortgage market and support over $5 trillion in mortgage backed securities with little to no capital. Second, as the safety and soundness regulator, he intends to take steps to reverse that situation.
Hopefully, these steps will be taken in concert with the U.S. Treasury, however, the director was clear he would take action, if necessary, on a solo basis.
The big lesson that came out of the 2008 financial crisis is that there is no substitute for equity capital. Capital, in sufficient amounts, spelled the difference between survival and failure for banks and other financial institutions. Those with a strong financial cushion survived, and those without one did not.
The Main Street Coalition — an informal group of small mortgage lenders and affordable housing groups — believes this issue is of vital importance. The one thing we learned in the financial crisis is that consumer access to mortgage credit is harmed — as is the broader economy — when sources of mortgage credit are compromised via undercapitalization.
The critical importance of this fact appears not to have been considered when it came to fashioning the Preferred Stock Purchase Agreements (PSPAs) between the U.S. Treasury and Fannie Mae and Freddie Mac, commonly referred to as government-sponsored enterprises (GSEs).
You may recall that these two federally-chartered mortgage giants were placed in conservatorship in September of 2008 as the mortgage crisis was reaching its peak because their capital situation was imperiled. As part of the conservatorship, the U.S. Treasury entered into PSPAs with each entity, promising to extend $200 billion in lines of credit to each company in return for senior preferred stock and warrants equivalent to nearly 80 percent of the common equity of each company. Lines of credit are not capital.
Subsequent to being placed into conservatorship, the Obama Treasury Department presented a plan to the Office of Management and Budget (OMB) that would have required the GSEs to have a $10 billion capital buffer until 2020. However, under the terms of the August 2012 amendment to the Preferred Stock Purchase Agreement, capital for the GSEs was frowned upon.
Rather than acknowledging the importance of capital to ensure safety and soundness, the PSPAs, as amended, required the GSEs to shed their existing capital by $600 million per year, until they reach zero on January 1, 2018. So today, the plan to strip their capital has continued — even though Fannie and Freddie have repaid not just the $185 billion advanced in 2008 — but an additional $75 billion in profits to taxpayers.
In 2016, Fannie Mae and Freddie Mac purchased $941 billion of single-family mortgages out of a total loan market of $2 trillion. The mortgage-backed securities issued by the two entities accounted for 65 percent of all mortgage securities backed by single-family loans in 2016. Additionally, the two GSEs are vital sources of financing both to low- and moderate-income home buyers, and they provide affordable financing to rental units that serve those same income groups.
Yet these two entities, which together form a vital part of the foundation of the home loan market in the U.S., will be running on zero capital by the first of next year. This dangerous reality is the result of a decision by senior officials in the prior administration.
Understandably, the agency that acts as both prudential regulator and conservator for the GSEs is quite concerned about the prospect of having these two giant organizations running on zero capital in less than 12 months.
Both organizations have generated significant earnings over the past several years, all of which have been paid to the U.S. Treasury pursuant to the terms of the PSPAs. But as Director Watt pointed out, a loss in a single calendar quarter could be realized through non-credit factors, such as a paper loss on a hedging position, which would be reversed the next quarter.
However, the PSPAs as currently structured, would require the GSE suffering the quarterly loss to take a draw from the Treasury in order to avoid a negative capital position. In turn, there could be unforeseen consequences from such a draw, which FHFA as conservator is focused on avoiding since the consequences for the U.S. mortgage market could be so severe.
Director Watt and FHFA are correct to be concerned about the potential consequences for running these two companies on zero capital, and they are right that these two companies are so vital to the U.S. mortgage market that they would be remiss in gambling on the prospect that future draws under the PSPAs would not cause any disruption of the market.
Their concern is absolutely appropriate for a conservator charged with safeguarding the assets of the two companies and guiding them back to financial health, as well as for a soundness regulator charged with protecting American taxpayers.
There are interest groups in Washington that shrug off the potential consequences of market disruption. They are willing to risk the unknown, unforeseen consequences of a Treasury draw and possible disruption of a $5 Trillion global MBS market and subsequent disruption of the U.S. housing market.
Their perspective is contradicted by the views stated by Director Watt, going back more than a year ago. The mortgage market and the ability of American consumers to finance the purchase of a home for their families is too important to be left to chance.
Director Watt and the FHFA have our full support to take the steps necessary to allow the GSEs to build a capital buffer, to protect taxpayers and avoid gambling with the health of the mortgage market.
Scott Olson is the executive director of the Community Home Lenders Association, whose mission is to promote federal housing policies that increase affordable mortgage loan options for homeowners and borrowers. Glen Corso is the executive director of the Community Mortgage Lenders of America, which was founded out of concern that emerging federal policies threaten to severely diminish community based lending, while increasing concentration among the nation’s largest financial institutions. Hilary Shelton is the director of the NAACP Washington Bureau and senior vice president for policy and advocacy.