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Fed Governor Jay Powell Sounds The ‘Alarm’
Yesterday, Federal Reserve Governor Jay Powell sounded the ‘alarm’ that the state of U.S. housing finance is at a perilous moment. This warning should not be taken lightly, as housing and construction make up a sizable share of the U.S. economy and contribute greatly to employment. Housing finance has significant implications, and risks, for the broader U.S. economy and financial markets. The availability of investor capital, or lack thereof, is essential at funding home ownership in America. It’s a grass-roots problem which is often treated as an academic one.
For years, inaction by Congress, the Executive branch, and the U.S. Treasury have brought us to this moment; within six-months, there will be no private capital standing behind the entities which turn individual mortgage loans into securities for purchase by private investors. Governor Powell is well aware that we cannot risk having increased uncertainty about the U.S. government’s commitment to its financial markets and such major contributors to the country’s GDP and employment.
With Congress rather dysfunctional, the time is now for the Executive Branch and U.S. Treasury to act independently, showing support for these important issues. They must end the uncertainty that is growing with each passing day. Investors who purchase these mortgaged-backed securities will not wave a flag to bring attention to their concerns, but they will withdraw their interest in the market and in mortgage-backed securities.
Fed Governor Powell is waiving a big flag.
Investments in mortgage-backed securities are essential — as they underly the U.S. housing stock in America. Make no mistake that investors have other choices. Many of them.
Fannie Mae and Freddie Mac Remain Committed
As Government-Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac remain committed to serving a broad range of homeowners, including first-time homebuyers and those in underserved communities. They are mandated to securitize individual mortgages even in challenging market conditions — when other market participants would rather not participate.
By doing so, they ensure necessary and valuable liquidity to the markets. It is clearly time to rebuild the financial buffer between the GSEs and taxpayer funds — with taxpayer funds acting as a very last backstop in support of the critical U.S. housing and construction markets.
It remains to be fully understood why some members of Congress seem so ready to dismantle Fannie Mae and Freddie Mac, as they provide an essential gateway for home ownership in America.
Clearly, replacing the GSEs would surely please the special interest lobbying groups and the “Too Big To Fail” banks which likely covet the securitization business as a potential source of additional profit and market dominance. We cannot afford to let smaller independent community banks be “boxed out” by these larger entities.
Fannie and Freddie Have Shown Enormous Financial Strength
U.S. Government’s Return on Investment: 100%
Part of the government’s $187.5 billion investment in the GSEs was used to bail out the “Too Big To Fail” banks by having the GSEs purchase bad loans from the TBTF banks, and writing off the losses on the financial statements of the GSEs as opposed to the TBTF banks.
In the years since the 2008 financial crisis, the GSEs have shown enormous strength in overcoming the country’s worst financial situation in many decades. The GSEs have paid back the $187.5 billion given to it during the crisis, plus $78.5 billion more, giving the government a nearly 42% return on its investment. With a total payment to the U.S. Treasury of $266 billion so far, the GSEs have proven resilient.
The plan to stabilize the housing finance market by investment bank Moelis & Company outlines how the U.S. Treasury could further profit by an additional $75 billion to $100 billion by selling its nearly 80-percent equity stake in the GSEs. Factoring this in would lead to an 82% to 101% return on the government’s original investment.
Fannie Mae and Freddie Mac are currently forced to pay 100-percent of their earnings to the U.S. Treasury. It’s an action referred to as the “Net Worth Sweep.” It’s been many years since the financial crisis and Congress has not acted to unwind government control and the effective nationalization of the GSEs. The government must free these privately-held and publicly-traded mortgage companies which are so vital to the U.S. housing industry. It is time to free them from government control while respecting the rights of the minority shareholders — the 20%.
Common shareholders, such as myself, are hoping that their lawful ownership interests in the GSEs will once again have underlying economic value. It’s hard to believe that de facto nationalization of Fannie Mae and Freddie Mac could happen and persist in the United States. This should be no more tolerable than if there were a nationalization of the mortgage units of J.P. Morgan, Goldman Sachs, Bank of America, or Citigroup.
Keeping the Net Worth Sweep is an embarrassment to our values as a nation and private property rights.
Critics Of The GSEs Have Vested Interests
Critics of the plan by Moelis & Company to recapitalize the GSEs — and indeed the powerful banking lobby — argue that they are taking the “moral high ground” because holders of the remaining 20-percent interest in the GSEs will profit from implementation of reforms. They argue that greedy “hedge funds” will make a profit, or recover their investment.
They do not mention the broad range of underlying investors in hedge funds which are typically pension plans, university endowments, state and local governments, foreign investors, and ordinary individual investors. The critics certainly do not mention which unspoken entities are lining up to receive 100% of the GSE business.
If the GSEs are ‘unwound,’ those funding the powerful banking lobby will likely be more than happy to assume the securitization role currently being performed so well by the GSEs. The motivations to dismantle the GSEs are transparent.
It’s Time To Rebuild Fannie and Freddie’s Capital and Re-list Them On The NYSE
The GSEs should be released from government control, re-listed on the New York Stock Exchange, and allowed to retain their profits — all while under prudent government supervision and capital controls.
If not, raising private capital to backstop any new entities would be most difficult — given that that GSE investors (i.e., the predecessors to any new entities) will have been wiped out by government action in the process. The precedent of wiping out private capital, and in the process also destroying the government’s nearly 80-percent interest in the GSEs, would make little sense.
The importance of the U.S. housing market is clear and should not be recklessly experimented with.
Currently, the U.S. Treasury has essentially received full principal repayment and all interest due under the original ‘bailout' agreement. There is some merit that the government’s 80-percent ownership interest was meant solely as a backstop to be monetized if the GSEs struggled to pay back the principal and interest. In such case, cancellation of the government’s warrants would be entirely in order.
This situation does not seem entirely unlike what was faced by AT&T (my former employer), which was sued many times by the Justice Department on antitrust grounds -- even though AT&T itself was a fully-regulated and legal monopoly under lawful government charter.
In the case of AT&T, Justice wanted to take AT&T apart, and asked management to deliver quote, “arms and legs” as part of any settlement. Shareholders were allowed to keep their lawful ownership interests in the various entities that resulted. In the case of Fannie Mae and Freddie Mac, the Justice Department and U.S. Treasury have not acknowledged lawful shareholder interests. They seem to be working to shut down shareholder rights entirely.
Independent Community Bankers: “Shareholder Rights Must Be Upheld”
As the Independent Community Bankers Association stated, “The GSEs must be allowed to rebuild their capital buffers…GSE shareholder rights must be upheld. Any reform of the housing finance system must address the claims of GSE shareholders and respect the rule of law that governs the rights of corporate shareholders.”
Accordingly, the rights of GSE common and junior preferred shareholders should be upheld. Lawyers for the U.S. Treasury have recently begun to argue that investments made at different times come with different shareholder rights — and in this case seemingly no rights. If the rule law can shift so drastically, investors will clearly be far more reluctant to risk their capital in the future. In this case, it is the capital which funds the vital U.S. housing and construction markets.
It would seem that sorting out these issues may go all the way to the U.S. Supreme Court if necessary, with the risk at destabilizing financial markets in the meantime.
It’s time to let the GSEs rebuild their capital base and re-listed their shares on the New York Stock Exchange. It’s time to let the common shareholders have their lawful 20% ownership interest in these vital companies. It’s time to do the right thing.
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