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Opinion, commentary and analysis on everything that makes the U.S. housing economy tick -- not to mention the ghosts in the machine, too. Written by HW's team of editors and reporters each business day.
Investments

The fuzzy math of mortgage bankers

A response to MBA CEO David Stevens

February 28, 2016

[Editor's note: There are many assertions in this blog. It is highly recommended that one review the original piece (click link below) by way of comparison.]

In a recent HousingWire article published on February 22, 2016,entitled “The Math Behind the Need for GSE Reform," Mortgage Bankers Association CEO David Stevens articulates several points relating to the conservatorships of Fannie Mae and Freddie Mac (collectively the “GSEs”) which merit close scrutiny against the facts. 

As background, much of Mr. Stevens' article focuses on issues related to the “Third Amendment” to the GSE Preferred Stock Purchase Agreements (“PSPA”). An agreement executed on August 17,2012 by the U.S. Department of the Treasury (“Treasury”); the Federal Housing Finance Agency (“FHFA”) and (with a metaphorical gun to their heads) the boards of Fannie Mae and Freddie Mac. This agreement replaced requirements in the prior agreements that the GSEs would pay the Treasury a 10% dividend. Instead, the Third Amendment required the sweep of 100% of any declared dividends to Treasury. Since the return to profitability by the GSEs, 100% of their income has been paid, as dividends, to the Treasury. In Mr. Stevens’ article claims: 

“If the [net worth sweep] had not been in place … Freddie [would have] had to pay the 10% dividend (as required in the prior PSPAs)”. This claim suggests that Mr. Stevens is either ignorant about the reality of the terms of the agreement or, worse, intentionally misleading. The 10% dividend is not legally required at all – and especially not in perpetuity. The contract is nothing more than an agreement between two government agencies and could be amended at any time without congressional approval.  As was the case with AIG, where a 10 percent cumulative dividend was reduced to a 5 percent non-cumulative dividend, and eventually to no dividend. 

Furthermore, there is no contractual or statutory requirement for the GSEs to pay the Treasury a cash dividend – let alone that they have to permit all of their profits to be swept into the Treasury each quarter in perpetuity. To suggest otherwise is fallacious and must be recognized as what it is, the propaganda of the handful of "too big to fail" members of the MBA who would benefit from a wind-down of the GSEs. In reality the net worth sweep was almost certainly devised as a way to use GSE income to help the Administration delay having to come to an agreement, with Congressional Republicans, regarding the debt ceiling. 

Still, it is important to point out that, according to Section 2(a) of each GSEs' amended PSPA, the decision to transfer all of each GSEs quarterly income to Treasury is not contractual. In fact, as stated in these agreements “for each Dividend Period from January 1, 2013, holders of outstanding shares of Senior Preferred Stock shall be entitled to receive … if declared by the Board of Directors, in its sole discretion … cash dividends in an amount equal to the then-current Dividend Amount.”  The phrase “if declared” demonstrates the boards of directors at each company may elect not to declare dividends. Prior to the Third Amendment the GSEs had an option to choose accrual of the dividends in additional future stock at a rate of 12% per annum.

Mr. Stevens then suggests the mark-to-market valuations of Fannie and Freddie’s derivative books could (and most likely will) cause another taxpayer draw, absent their ability to retain earnings. While this is an accurate statement Mr. Stevens then wrongly asserts that derivative “volatility” caused by “significant quarter to quarter” marks is the primary driver of taxpayer exposure. Again, there is no contractual or statutory basis for requiring that all net income be swept to Treasury on a quarterly basis.  That decision resulted from a desire by Treasury, the White House National Economic Council, and the Department of Housing and Urban Development to ensure the GSEs would continue to be susceptible to future draws. The intent appears clearly to have been motivated to increase pressure on lawmakers to pass “reform” legislation, such as the legislation introduced by Senators Corker and Warner.  That legislation, which was supported by few trade associations other than the Mortgage Bankers Association, would have handed the mortgage insurance market to MBA’s largest lenders. 

If policymakers were genuinely concerned about the prospects for a future draw from Treasury and wanted to avoid one, they would choose to calculate the sweep on an annual rather than quarterly basis.  As an example, if the companies had three quarters of strong earnings that could offset one bad quarter of earnings, there would be no draw if calculated on an annual basis. Treasury explicitly designed the net worth sweep with the intent to force another draw.

In addressing Fannie and Freddie’s “$250 billion” Treasury commitment, the article misrepresents that this line of credit will “guarantee against [GSE] defaults.”  Factually, the PSPAs contain an explicit “disavowal of guarantee” which was interpreted by the New York Federal Reserve on September 11, 2008, to mean “Treasury’s commitment ‘shall not be deemed to constitute a guarantee’ by the United States of the payment or performance of any debt security of the GSEs.”  To suggest that the GSEs should be charged for a guarantee that isn’t actually a guarantee is incorrect. 

In addition, former Acting FHFA Director Edward DeMarco failed to classify the GSEs as “critically undercapitalized” because of Treasury’s financial support – which, as I addressed above, is not actually capital support.  Were the GSEs to be classified as critically undercapitalized, as they are by any measure of safety and soundness, they would be in receivership today rather than in perpetual conservatorship.  So, why hasn’t FHFA directed the GSEs to prepare and submit capital retention plans as required under HERA when the companies are critically undercapitalized? Suspending the classification altogether, as FHFA did, doesn’t mitigate the fact that Fannie and Freddie are critically undercapitalized. FHFA Director Mel Watt’s speech on February 18, 2016 only reinforces this point. 

It is also important to highlight that I am aware of no other legally binding financial contract that has ever been structured in a way that prevents the obligation from being extinguished or refinanced with other capital.

Mr. Stevens’ suggestion that Treasury actually wanted the GSEs to become adequately capitalized (as statutorily required by HERA), but that the companies simply haven’t been able to rebuild capital doesn’t reconcile with the actions of Treasury or the FHFA.  To claim that the math indicates the GSEs cannot become adequately capitalized with private capital is also incorrect. The only thing barring the GSEs from prudent recapitalization is the usurious contract terms that were tailored to prevent precisely what the HERA statute requires.

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