When should GSE recapitalization occur?
Written By: Joel Palmer, Op-Ed Writer
The future of the two government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac has become the mortgage industry’s version of the classic chicken-and-egg dilemma.
Which should come first?
Should regulators recapitalize the GSEs now or at least in the very near future as a way to boost reform efforts?
Or would it be better for the Trump administration to continue the focus on fixing the structural flaws that led to the breakdown of the housing finance system and to the current conservatorship arrangement before recapitalization occurs?
It’s been an ongoing debate, one that intensified late last month when Fannie Mae and Freddie Mac paid their $10 billion quarterly dividend to Treasury as a result of their recent earnings.
It had been speculated in many circles that the dividend payments would be suspended, allowing the GSEs to keep that capital for themselves. Such a move would have signaled a key first step in recapitalizing and ultimately re-privatizing the two entities.
Alas, that didn’t happen and the payments were made. And the debate continues.
On one side are those who favor maintaining the status quo, at least until significant legislative reforms have passed that minimize the risk of a repeat of the housing collapse. This stance is championed by a number of housing organizations, namely the National Association of Realtors and the Mortgage Bankers Association.
One of their main arguments is that the conservatorship arrangement provides a substantial line of credit held by Treasury, minimizing the risk of an adverse market reaction. A recapitalization effort, on the other hand, would take decades to provide the GSEs their own safety net current equivalent to that provided by Treasury.
Others have cautioned that removing the GSEs from government control would lead to higher mortgage rates because private investors will not want to take on the risk that the federal government has assumed for mortgage-backed securities.
On the other side of the debate is the concern that the current arrangement will Treasury limits how much of their net worth Fannie and Freddie can retain, an amount that falls to zero in 2018.
As one industry observer recently wrote: “We now have companies that back up more than $5 trillion in mortgage debt sitting in political limbo with zero capital.” Furthermore, the argument goes that the two entities have been profitable for five years proves they no longer belong in conservatorship.
This side of the debate is being pushed by the Community Home Lenders Association (CHLA). The organization has advocated for an immediate end to the GSE dividend payments to enable them to build a sufficient capital buffer. It has also called for the FHFA to develop a capital restoration plan under which they are re-privatized and taken out of conservatorship.
In a recent post, the organization wrote: “CHLA believes that the best approach is a Utility Model, in which the GSEs build up capital to enable them to exit the conservatorship and re-emerge as private entities, in which they perform a mortgage securitization and standardization role, supported by a government backstop of their MBS. Taxpayers are protected by private GSE capital; third-party credit risk transfers to absorb losses; robust FHFA regulation of underwriting standards and counter-party risk; fees to cover the risk of the backstop.”
Those who can actually make recapitalization occur have given, at best, mixed signals about their intentions. During the presidential campaign, President Donald Trump indicated a desire to move the GSEs out of conservatorship as quickly as possible. Treasury Secretary Steven Mnuchin said after being nominated that ending the arrangement was a top 10 priority and that his department would end government control of Fannie Mae and Freddie Mac once officials can ensure “that when they are restructured, they are absolutely safe and don’t get taken over again.”
But Mnuchin softened his stance on privatization during his January confirmation hearing. In February, a lawsuit brought by GSE investors to halt the dividend transfers was rejected by the U.S. Court of Appeals for the District of Columbia Circuit. Then last month, a Reuters report stated that Congress likely won’t even address an overhaul of Fannie and Freddie on this year's legislative calendar.
So assuming the status quo remains in effect indefinitely, it would seem that reform will continue to play the role of chicken that eventually lays the egg of recapitalization.
Or is that the egg of reform hatching the chicken of recapitalization?
About the Author
As an NAMP® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.
