No way to run a railroad
Virtually everyone knows that Amtrak is the US government owned passenger rail service. And every 5-year-old knows what a railroad does[1]. While delayed by over 20 minutes on the train from Milwaukee to Chicago, however, it dawned on me that Amtrak might be an example of what Fannie Mae and Freddie Mac might be now. No longer merely government “sponsored” enterprises, for the past 15 years they have been fully government-controlled actors conducting business in the marketplace, except Amtrak has never made a profit in over 50 years.
While you’ve heard of Fannie and Freddie, not many people (not even many Musings readers) truly understand who they are, what they do, and why they exist to facilitate the origination, sale and servicing of the vast majority of all home loans made in the United States. Yet, their underwriting and servicing requirements for conventional loans control the origination of mortgages and sale of mortgage securities covering the vast majority of all US loans. When you include other governmental programs, such as FHA/VA you are talking about nearly 100%[2] of the entire home loan market[3] being essentially run by the federal government.
Government control
I don’t claim to be an expert on Fannie and Freddie, but it is fair to say that these creatures of the federal government defy common understandings about how government and markets normally operate in this country, even for highly regulated industries like utilities. Since their inception well over 50 years ago they have existed in a netherworld between government and private industry. But, with the crisis mentality of the Great Recession period far in the rearview, no one currently seems too interested in unpacking and revisiting their rationale and structure.[4] “If it ain’t broke, don’t fix it[5]”, right? But what does ain’t broke even mean in this context?[6]
Originally structured as privately held[7]federally chartered corporations, it has now been 15 years since Fannie Mae and Freddie Mac were put into government conservatorship under the Federal Housing Finance Agency (FHFA): the independent regulatory agency Congress created to oversee Fannie and Freddie in 2008.[8] All of Fannie’s and Freddie’s shareholders were wiped out in the process (similar to a bankruptcy).[9] Essentially, Fannie and Freddie have been acting at the direction and control of the federal government without any shareholders to vote on directors or trade in the stock for over 15 years.[10] Despite being nominally business corporations, FHFA wields all of the powers of management, board of directors, and shareholders. There is zero likelihood this situation will change any time soon as Congress is inept,[11] the President lacks a cohesive housing policy strategy and FHFA no longer has an activist Director looking to get them out of conservatorship.[12]
Additionally, all of the earnings of Fannie and Freddie while in conservatorship, totaling billions of dollars, have been swept into the US Treasury.[13] Those earnings have more than covered the initial losses that put them into conservatorship in the first place. This has resulted in substantial payments to the US Treasury (effectively reducing a small portion of the national debt[14]) which is generally seen as good for taxpayers,[15] but how else might those profits be used to further government housing objectives?
Secondary market role
Fannie and Freddie exist primarily to facilitate a secondary market for home mortgage loans that would otherwise might have to exist as portfolio loans on a bank’s balance sheet. The GSEs specify uniform underwriting and loan servicing quality backed by an enormous balance sheet[16] to comfort investors’[17] concerns about repayment of loans that enables a liquid market to exist in trading uniform mortgage backed securities (UMBS).[18] Downstream of that “Wall Street” mortgage financing liquidity are consumer mortgage borrowers and mortgage originators who must meet GSE underwriting requirements in order to get fixed rates amortized over a period of up to 30 years or more that otherwise would be unlikely to be available without that standardization and backing.[19]
According to Robbie Chrisman,[20]“Fannie’s and Freddie’s active and government-guaranteed (implicit or explicit )[21]secondary market for conforming conventional loans provides market participants around the world stability and liquidity that allows for prices and yields of UMBS to track the U.S. Treasury market relatively closely versus private-label MBS securities based on jumbo or non-QM loans. It is worth noting that Fannie and Freddie never stopped buying loans during the Financial Crisis.”
So, one way to look at it is that Fannie and Freddie work just fine for secondary market investors, but that could change.
The Amtrak model?
To be clear, I am not advocating for running Fannie and Freddie like Amtrak[22], but perhaps that kind of thing is inevitable in a fully government-controlled business. Presently, only an “independent” FHFA whose director is accountable only to the President is stopping politicians and interest groups from co-opting Fannie and Freddie’s mission to achieve political or parochial objectives rather than profitable ends. What might happen, for example, if FHFA, Congress or a Presidential administration got their policy act together and gave Fannie and Freddie a clearer mission more driven by socio-political interests instead of a profit motive?
Consider, by way of analogy, the following paragraph in favor of abandoning a profit motive from Amtrak: Future of American Transit or Failed Experiment? – Berkeley Economic Review, and substitute Fannie and Freddie for Amtrak:
This brings up the question about Amtrak’s purpose as a company. Instead of viewing Amtrak as a money-maker, what if we instead looked towards Amtrak’s ability to connect communities, and boost local economies through both business and leisure travel? What if we recognized the power of rail as a better driver for socioeconomic mobility compared to automobile travel, creating new opportunities for employment and education? What if we acknowledged the myriad of environmental benefits of Amtrak’s train services, from lower carbon emissions to taking up fewer precious urban and natural spaces? The next time you hear about how unprofitable Amtrak is, take a moment to think about all the things that are not factored into the bottom line.
Perhaps it’s a darn good thing that most people don’t understand what Fannie and Freddie actually do or politicians might just develop their own ideas on how they could spend their profits to achieve desirable social outcomes instead of just giving money back to the federal government. How that might play out for Fannie and Freddie is, of course unknown, but I’ve offered a couple ideas below.
Assumptions about assumptions
Some grizzled mortgage executives might clamor about UMBS market expectations and sanctity of contracts[23], but the lesson of COVID forbearance is that when the government controls the mortgage lending industry, it can change the rules[24] to accommodate social, political or economic interests. In that regard, the federal government has been aware of the housing supply shortage for at least 2 years. The White House specifically, but also FHFA, Fannie Mae and Freddie Mac all started talking about it in 2021.
What if, for example, Fannie and Freddie (at FHFA’s direction) decided to increase housing supply by encouraging more homeowners with low interest rates to sell and move without having to give up the embedded value of below current market rate loan; i.e., enable loan assumptions. They could just as easily tell servicers they didn’t need to enforce due on sale clauses as they could tell servicers to agree to COVID forbearance. UMBS purchasers at the low rates immediately after COVID stimulus efforts can’t really claim they have a reasonable expectation that the government will strictly enforce anything in the face of other policy decisions like forbearance and loan modifications. All those investors really bargained for was the credit risk insurance from the government. They assumed the duration risk along with the risk the government would enforce its servicing policies in politically expedient ways rather than more strictly adhering to the lender’s rights.[25]
Repurchases
Similarly, the fact Fannie and Freddie are still quite profitable while the mortgage banking businesses has been terrible, has not been lost on many in the industry. This is particularly true when considering the notable increase in repurchase demands over technical and immaterial issues the industry has seen over the past year or two.[26] As reported in Housing Wire and other outlets, Mat Ishbia, the CEO of the nation’s largest mortgage lender recently said in a video,
“They are making billions, and lenders are barely scraping by, but they continue to make them buy back loans for small reasons here, little things that happened on a loan that maybe are not impacting the borrower’s success in that loan…, the FHFA years ago took action so Freddie Mac and Fannie Mae would not push back loans for illogical reasons, small reasons left and right or after a 36-month window. However, it doesn’t seem to be working,”
Ishbia’s point about the process[27] for disputing repurchase demands not working is even more important if Fannie and Freddie are government rather than private actors in a time with many challenges to excessive government power are circulating in the federal judiciary.[28] Meanwhile, all of these repurchase demands are particularly confusing at a time when the only discernable federal housing goal is seeking housing equity. Passing huge losses back to originators for immaterial and technical violations acts as a massive disincentive for mortgage bankers to seek and approve marginal borrowers. This is directly at odds with any housing equity goals in the same way that overly zealous enforcement of False Claims Act violations caused many banks to exit the FHA market entirely.[29]
Post Script (Pre-Script?)
One day after posting this edition I heard David Stevens’ Housing Wire podcast from September 13, 2023 in which he discussed remarkably similar topics and thoughts. I had not heard it prior to drafting and posting this edition, but I have nevertheless, apologized to Dave because I wish I could have used that as further support (with proper attribution). Along with the entire industry, I wish Dave the best in his latest clinical trial.
[1] Most 5-year-olds are, in fact, experts in the subject of trains.
[2] I’m setting aside portfolio and jumbo loans that are for people who generally don’t need any government help.
[3] According to Chris Whelan, “Fact is, virtually the entire residential housing sector currently operates with government credit support, so that investors need only ponder market risk and funding. Sadly, Silicon Valley Bank forgot that option-adjusted duration thing. But the key point is that virtually the entire market for 1-4 family mortgages reflects a government subsidy worth several points in terms of loan price. Keeping the GSEs in conservatorship simply makes this middle-class subsidy a permanent fixture of the mortgage markets.”
[4] By contrast, there are lots of folks interested in unpacking and revisiting the rationale and structure of the CFPB. See e.g., Ed. # 53: 5th Circuit Follows the (CFPB’s) Money (mortgagemusings.com)
[5]I’m pretty sure “if it ain’t broke don’t fix it” is FHFA’s current mission statement re Fannie and Freddie. Just kidding, see Fn. 8.
[6] To know if something works, you have to know what you want it to do. Who gets to decide that?
[7]There was a progression from being mostly bank/thrift owned to fully publicly traded entities.
[8]Per its website, FHFA’s mission is to ensure that Fannie Mae, Freddie Mac, [and the Federal Home Loan Banks] “fulfill their mission by operating in a safe and sound manner to serve as a reliable source of liquidity and funding for the housing finance market throughout the economic cycle.” I’m not sure exactly how, “throughout the economic cycle” changes that mission statement, but I’m guessing a reminder that the economy has ups and downs was important for policymakers.
[9]Some of those stockholders continue lawsuits to this day to get paid for what was taken away, but winning on a 5th Amendment/takings argument type claim might only make my broader case for the current government ownership stronger.
[10]Per the FHFA website, “As conservator, FHFA has the powers of the management, boards, and shareholders of Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac continue to operate as business corporations. FHFA is responsible for the overall management of Fannie Mae and Freddie Mac and has informed the Enterprises which decision-making functions should be performed by the Enterprises’ boards of directors and/or management teams. The boards and management teams must consult with FHFA and obtain conservator approval as FHFA directs. Overall, the conservator has ultimate authority over all operations of the Enterprises.”
[11]In 2013, CFPB thought for sure Congress would be able to get GSE reform done in 8 years. They were wrong. So the GSE Patch expired in January 2021 and CFPB came up with another way to define a QM loan that satisfied the secondary market UMBS investors. As for Congress now; “dysfunctional” may be the best adjective.
[12]Former FHFA Director Mark Calabria wanted to “recapitalize and release” the GSEs back to the private sector, but current FHFA leadership seems to have other priorities, such as looking at the Federal Home Loan Banks: which won’t be an easy task either..
[13]Interestingly, they also continue to pay federal taxes on their income during their conservatorship.
[14]The national debt is over $33 trillion (and counting), so those profits are a small contribution as a percentage, but enough, for example, to cover the costs of weapons provided to Ukraine.
[15]Only if you believe that the national debt is something that eventually needs to be repaid. But see Modern Monetary Theory (MMT).
[16]Perhaps a balance sheet that can print money whenever it needs it?
[17]“Investor” is what people in the mortgage industry call the owner of the loan (party getting the interest and entitled to foreclose if the loan is not repaid). It generally doesn’t refer to someone who invests in a mortgage company.
[18]Sometimes Fannie and Freddie are the investors and sometimes they just make the representations and warranties for securities issued to other investors who own the rights to those UMBS.
[19]Would they? That is, whether a viable private industry marketplace for UMBS could develop in the absence of Fannie and Freddie deserves serious study by the nation’s economists and not just off-hand commentary by pundits like me. Perhaps the only needed government role is to step in during times of economic stress such as when the Fed purchased UMBS during the pandemic.
[20] Robbie’s daily podcast can be found at www.robchrisman.com, but most of you know that already. It will be interesting to see if Robbie transitions to simply being called Rob when he unplugs his father’s life support to charge his phone. Also, I always consider the “Dread Pirate Robert” story from the Princess Bride movie whenever I mention Rob and Robbie in the same thought.
[21]Investors used to wonder about whether Fannie and Freddie’s obligations had the “implicit guaranty” of the full faith and credit of the US Treasury, making them essentially as safe as US government obligations. I haven’t heard much talk about “implicit guaranties” since 2008, but it’s even harder to imagine with the current government control situation (including net income sweeps) that the government could let them fail (again) without backing their debts.
[22] Whether Amtrak and rail travel should be privatized is beyond the scope of this punditry, but it would be fun to theorize about public transportation options generally if I was more knowledgeable about it.
[23] I was recently chastised by a trade association executive for my assumption idea, but I don’t think agency ordered forbearance was all that different from a contractual or market expectation perspective.
[24]In the case of forbearance, servicing guidelines were modified on the fly to enable borrowers to easily obtain forbearance just for asking and then borrowers were given multiple options for repayment other than whatever their loan documents normally provide for default. Exercise of servicing discretion by the GSEs in loss mitigation is similar to prosecutorial discretion where a government enforcement official decides not to prosecute a crime or to plea bargain to a different offense.
[25]It all gets very circular when you consider that the US Treasury is the largest single investor in UMBS, but Treasury is trying to unwind its balance sheet and was hoping that faster prepayments might help with that. So, I don’t think the Treasury would be happy if Fannie and Freddie enabled more loan assumptions but who do all these agencies work for anyway?
[26] Unfortunately, my prediction about this in 2020 seems to have been borne out. Edition #6: Ensuring GSE Pandemic Losses-Repurchases Redux? (mortgagemusings.com)
[27] I have discussed the importance of government providing a fair process for its actions often in these Musings. Usually I mention the CFPB’s regulations by enforcement in that regard, but see also e.g., https://mortgagemusings.com/f/ed-63-fhfas-pricing-grid-and-the-importance-of-process. I was kind of hard on FHFA in that Musing about failing to have a proper feedback process before announcing changes to underwriting requirements. To give credit where due, however, I was pleased to see that FHFA recently took a step back to consider the implications of certain credit score requirements more thoroughly before moving forward with implementing changes upon hearing industry concerns.
[28]The new SCOTUS term begins in October with CFPB funding and Chevron deference at the top of the docket. Meanwhile, Federal Circuit courts are grappling with injunctions against CFPB rulemaking and exam manual enforcement and appeals of fair lending interpretations. This should be a good year for a lot of financial services litigators who get paid by the hour, but perhaps not so good for CFPB and its lawyers who generally do not.
[29]Many lenders, especially big banks, however, are still feeling “once bitten/twice shy” about that.