Reconsidering Death Sentence For Fannie and Freddie

By: Jann Swanson • Tue, Oct 15 2013, 3:08 PM

There may be life in those old GSE bones yet. At least that is one conclusion that can be drawn from an article in Bloomberg on Tuesday. Writers Clea Benson and Cheyenne Hopkins write about some current Washington discussions about the future of Fannie Mae in a piece titled "Fannie Mae Survival is Back on the Table in Washington." The Bloomberg piece is an interesting complement to an analysis from Bank of America/Merrill Lynch which MND covered in August.

At that time Merrill Lynch Rates Strategists Ralph Axel and Priya Misra discussed saving both Fannie Mae and Freddie Mac, pointing to the GSEs' record financial performance in the previous few quarters, the substantial return the two had already made on the Treasury's investment in them, that they had needed no taxpayer support for over a year, and that during their conservatorships they have provided the bulk of the country's mortgage liquidity and completed several million foreclosure interventions. These results provide two key takeaways, the Axel and Misra said; 1) the GSEs function well as government-run entities, and 2) the infrastructure of mortgage finance is not in need of major reform.

The Bloomberg reporters find that the Merrill Lynch is not alone in its opinion at least as regards the larger of the two corporations but at the same time few seem interested in absolute salvation. The consensus in Washington, they say, is still strongly tilted toward dismantling the mortgage companies but it is "weakening amid opposition from hedge funds, regional banks and others who could benefit if the companies survive in some form." Their article, however, is more concerned about the timing involved in elimination of the GSEs than in whether they actually survive.

The official Obama Administration position is that Freddie and Fannie should be wound down and replaced by a new housing system but some Democrats, the Bloomberg writers say, are leery of a home financing system that would rely too heavily on private money. Both Senate Majority Leader Harry Reid (D-NV) and Banking Committee member Robert Menendez (D-NJ) have expressed some degree of support for keeping the GSEs.

More strongly in favor are a few hedge funds which have accumulated large holdings of the GSEs' preferred stock and, the Bloomberg article says, have spent months lobbying for their recapitalization. One of these hedge funds, Perry Capital, as well as Fairholme Funds have sued the U.S., charging that Treasury is "expropriating the value" of its investors' preferred shares through recent changes in Treasury's own agreement with the GSEs.

While the hedge funds didn't get far in their early meetings with senators, the authors say that the atmosphere is warming to the idea that an entirely new system could risk instability in the market. The primary piece of active legislation pushing a totally clean start is the so-called PATH bill sponsored by Jeb Hensarling (R-TX) Chair of the House Financial Services Committee which would eliminate virtually all government involvement in housing finance except for a scaled-down role for the FHA. The PATH bill has been voted out of committee but Benson and Hopkins say it is unlikely to receive a full House vote this year.

More likely to be the legislative vehicle is a bill sponsored by Tim Johnson (D-SD) and Mike Crapo (R-ID) which incorporates parts of the earlier Corker-Warner bill which would wind down Fannie and Freddie over five years. If would keep the government involved in finance through a catastrophic guarantee that would come into play only after private funds had absorbed a certain level of losses.

According to the Bloomberg article, regional and community banks are concerned that they will be shut out of a new system without entities like Freddie and Fannie available to purchase and securitize the loans they write. At the same time large banks and others appear most worried about a too precipitous wind down. Some say it is unclear whether private capital will be willing to take a first-loss position should the GSE guarantees go away. Others say the five-year window is too aggressive.

One very strong voice for a continued Freddie/Fannie presence represented in the article is James Millstein, CEO of Millstein and Company and author of a recapitalization plan for the enterprises, but even he seems most concerned with timing. He told the National Press Club this month that, "As much as it's problematic in this town for people to stomach the idea that these entities are going to survive, we have to reform and recapitalize and privatize them to ensure stable credit formation during this transition to a new government guarantee

Bob Corker (R-TN), sponsor of the Corker-Warner bill said that the survival of the essential functions of the GSEs does not mean that the companies themselves must survive. His bill, he said, "outlines a very clear picture for a future state of housing finance that does not rely on the duopolies of Fannie and Freddie, but it smartly leverages the existing technology and infrastructure already built in order to help us get there."

Benson and Hopkins say that Republicans, who have been most vocal about the need to eliminate the two companies, haven't budged. Many of them were fighting to reduce the GSE housing footprint long before the financial crisis.

The authors also say that Republicans and Democrats in general have shown little enthusiasm for a solution that would appear to reward investors more than taxpayers. Corker and his bill's cosponsor, Mark Warner (D-VA) say it would be possible to preserve some parts or functions of the mortgage companies without benefitting shareholders.