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May 14, 2019

The Fannie and Freddie 10 year conservatorship may be over… Are we ready? announces: “Trump officially calls for an end to Fannie Mae, Freddie Mac conservatorship “does this mean days are numbered for the two government-sponsored entities?

The President signed a memorandum last week calling for “overdue reform of the housing finance system” including the end of conservatorship and the improvement of the regulatory oversight of both entities. These two were bailed out in 2008 to the tune of 180 Billion dollars by the United States Treasury and have remained in government control the last 10+ years and are referred to as Government Sponsored Entities (GSE’s).

The bailout money came with the caveat that U.S. treasury owned 79.9% of common stock as well as granted Senior preferred stock equal to the total amount of dollars they “borrowed” and would be paid 10% dividend every quarter if able and if not would accumulate more Sr preferred stock instead of the dividend.

Fast forward a few years toward the end of 2011 and all indications were GSE’s were about to start earning a tremendous amount of money. Also, tax loss write-downs they had taken and were highly overstated were about to come off the books. The Obama administration knowing these facts changed the rules for the GSE’s in 2012 and instituted what is known as the net worth sweep which required ALL profits generated by these two would be “swept” to U.S. Treasury. These funds did not have to be appropriated by Congress and were considered discretionary monies. We now know and was confirmed by current U.S. Treasury Secretary Mnuchin this money went to help pay for Obamacare subsidies which Congress was not going to appropriate funds. Hmmm, do you see any similarities to what is happening today in DC?

So since 2012 how much money has been swept to the treasury? If you said 100 BILLION more, you would be correct! The GSE’s cleaned over 280 billion dollars to treasury in the last 6 years and have become “cash cows” for treasury None of this has gone to repay the original bailout money, so GSE’s still own $180 billion of Senior preferred stock as well as 79.9% of common stock in 2 of the most profitable companies on the planet. Fannie is #1 and Freddie #3 of companies that generate the most profit per employee. That’s right; they create more profit per employee than the likes of Apple, Facebook and Microsoft

So what exactly is the problem here and what is this so-called “necessary” reform we keep hearing? Housing finance market appears to be working OK and these companies that enable 30 year fixed rate mortgages to take place seem to be functioning fine. Well, here’s the rub. Since all profits are going to the treasury, these companies retain very little in cash. Up until a few months ago, it was zero and now is just $3 billion each. This sits against a backdrop of mortgage-backed securities of these two plus Ginnie Mae at 5.5 Trillion. That’s right TRILLION. Do I have your attention now?

Things are humming along pretty well. Those who appear to be “mortgage-worthy” are getting one, and distressed sales are virtually nonexistent in most markets. However, we are and have been in a rising market price environment for the last 5 or so years. What happens when pricing takes a step backward, and home equity starts to take a hit?

Many studies have been conducted, and the result stated that GSE’s need between $150 to $200 billion in the capital. This would be more than enough to withstand another 2008 downturn. They now, as stated previously, have $3 billion each so $6 billion total. There is a lot of talk in DC about protecting taxpayers and avoiding another bailout of these two but what would be the end game if we were to experience another housing crisis? The Treasury still has a line of credit to the GSE’s of some $400 billion but if this is tapped into it will most certainly be called, and headlines will read “Here we go again… taxpayers to the rescue of the housing industry!”

So where does that leave us? Some, mostly in the Republican party, want to abolish Fannie and Freddie, get the government out of MBS and let big banks and others take the risk. If this were to take place and another 2008 were to happen, would the government take a different position this time and let the banks fail? Democrats who want to expand housing affordability goals feel this would not be helpful to their cause.

So are the days numbered for these entities?

In my research on this issue, it appears the following will take place:

*There is no reasonable alternative to preserving the 30 years fixed rate mortgage as we now know it, so GSE’s will be protected.

*The net worth sweep will be ended and GSE’s will be allowed to retain their profits.

*The government will stop the charters of the GSE’s and will enable them to be taken out of conservatorship.

*At the present rate of earnings it would take over seven years before capitol would hit the $150 billion mark and that’s at current profitable rates and no housing market downturn. More cash is needed and needed quickly. Therefore, I expect a capital raise in the form of the government selling their almost 80% of these HUGELY profitable companies. In an IPO, these companies are estimated to value the government shares worth between $100 and 150 billion dollars.

*Companies will be classified as regulated utilities with a rate of return advantageous for investors. *Government will continue to back MBS but will be compensated for this in the way of risk-rated G fee’s.

*GSE footprint will be reduced.

*There has been some talk of competitors being allowed to the GSEs in the form of guarantors to spread the risk around so to speak. I am not convinced at this time that will or will not happen, but in any event, more Credit Risk Transfers (CRT’s) will be offloaded from the GSE balance sheets.

Recently NAR President-elect Vince Malta stressed the importance of a continued federal guarantee of 30-year, fixed-rate conventional mortgages after government control of Fannie and Freddie is lifted. NAR earlier this year called for reforming the 2 companies into market utilities and Sen. Sherrod Brown, the ranking member on Senate Committee on banking, housing, and urban affairs, seemed in agreement, “Guarantors that are regulated utilities with regulated rates of return would serve all lenders and avoid a race to the bottom,” he said.

As I write this, news just hit that Mark Calabria, who has been serving as V.P Pence economic adviser, has been confirmed as FHFA Director. Calabria has long been an advocate for greater taxpayer protection against mortgage credit risk, including the use of private mortgage insurance to shield taxpayers and federal government from financial risk on low down payment lending. The move was applauded by National Association of Realtors (NAR) President John Smaby, “Dr. Calabria has decades of experience in the housing industry, including time spent as an economist at NAR, he understands the critical importance of the FHFA’s prudent management of America’s housing finance system. We urge Director Calabria to work closely with Congress in the effort to responsibly reform the GSE’s.”

Well, that’s my 2 cents, and I did not even mention the common securitization platform which has been in the works combining the two entities to issue a single MBS and anticipated for a June roll out. Well to quote one of my favorite movies “I’ll be back!”

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