March 24 2015: Senate Banking Comm. Hearing – Financial Stability Oversight Council Accountability and Transparency

We’ll have to wait for more details, especially to learn who is on the witness list for this hearing.  However, this hearing may be of interest to Fan and Fred followers as the Financial Stability Oversight Council is chaired by Treasury Secretary Lew and attended by Director Watt.

Senator Shelby, Feb 23, 2015:

“The role of the executive branch in regulating the financial sector has grown significantly over the past several years.  In light of this growth, the Banking Committee will closely examine several areas of the government that demand proper oversight,” said Chairman Shelby.  “We began the 114th Congress by examining the impact of regulations on community banks and credit unions.  The Committee will now take a deeper look into other areas of the government that should be both transparent and accountable to the American people.  It is my belief that we will discover several areas where there is bipartisan agreement that common-sense reform is needed.”

FSOC Member Agencies

FHFA Division of Conservatorship

The Division of Conservatorship assists the FHFA Director, as conservator, in preserving and conserving the Enterprises’ assets and property. The division facilitates communications between the Enterprises and the conservator to ensure the prompt identification of emerging issues and their timely resolution. The division also works with the Enterprises’ boards and senior management to establish priorities and milestones for accomplishing the goals of the conservatorship. Additionally, the division leads, coordinates, and clarifies agency and Enterprise activities related to FHFA’s A Strategic Plan for Enterprise Conservatorships.

Federal Housing Finance Agency Fiscal Year 2014 Performance and Accountability Report


Click to access 666956.pdf

This report was published in November 2014, though I personally just discovered it.  I thought the report would of interest to some.

My favorite word in the report is highlighted in the passage below:

In September 2008, after Fannie Mae and Freddie Mac were placed in conservatorship under the FHFA, the Office of Management and Budget (OMB) determined that the assets, liabilities and activities of the companies would not be included in the financial statements of the federal government. For fiscal year 2008, OMB and the Department of the Treasury (Treasury) concluded that Fannie Mae and Freddie Mac did not meet the conclusive or indicative criteria for a federal entity contained in OMB Circular A-136, Financial Reporting Requirements, and Statement of Federal Financial Accounting Concepts No. 2, Entity and Display, because they are not listed in the section of the federal government’s budget entitled “Federal Programs by Agency and Account,” and because the nature of FHFA’s conservatorships over Fannie Mae and Freddie Mac and the federal government’s ownership and control of the entities is considered to be  temporary.  Treasury reaffirmed this position, with which FHFA concurs. OMB continued to hold this view in the President’s budget submissions to Congress. Consequently, the assets, liabilities, and activities of Fannie Mae and Freddie Mac have not been consolidated into FHFA’s financial statements. However, Treasury records the value of the federal government’s investments in Fannie Mae and Freddie Mac in its financial statements as a General Fund asset.

I’ll have a Double Capuano – Brilliant Congressman Tries Again!

Congressman Capuano: “Payback Treasury!”


Congressman Michael Capuano is a Democrat from Massachusetts serving since 1998. Prior to that, Mr. Capuano graduated from Boston College Law School and served as an alderman, then mayor of his hometown, Somerville, MA. Among other responsibilities, Mr. Capuano serves on the House Committee on Financial Services.

On February 24, 2015, Mr. Capuano introduced “H.R. 1036: To provide for the repayment of amounts borrowed by Fannie Mae and Freddie Mac from the Treasury of the United States, together with interest, over a 30-year period, and for other purposes.”

Details are forthcoming on the bill, however in 2013, Congressman Capuano introduced a similar bill “H.R. 2435: Let the GSEs Pay Us Back Act of 2013.”

Details of that bill can be viewed here:

The bill had no co-sponsors, received no votes and its official status is “Died in a previous Congress.” The following is a summary of the 2013 bill:

H.R.2435 — Let the GSEs Pay Us Back Act of 2013 (Introduced in House – IH)
HR 2435 IH


1st Session

  1. R. 2435

To provide for the repayment of amounts borrowed by Fannie Mae and Freddie Mac from the Treasury of the United States, together with interest, over a 30-year period, and for other purposes.


June 19, 2013

Mr. CAPUANO introduced the following bill; which was referred to the Committee on Financial Services


To provide for the repayment of amounts borrowed by Fannie Mae and Freddie Mac from the Treasury of the United States, together with interest, over a 30-year period, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,


This Act may be cited as the `Let the GSEs Pay Us Back Act of 2013′.


The Secretary of the Treasury and each enterprise (acting through the conservator for the enterprise appointed pursuant to section 1367 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617)) shall enter into an agreement with that modifies the Preferred Stock Purchase Agreement for such enterprise to provide as follows:

(1) TERMINATION OF DIVIDENDS- That after such modification, any Senior Preferred Stock purchased under such Agreement by the Department of the Treasury shall not accrue further dividends.

(2) TREATMENT OF ENTERPRISE DRAWS ON TREASURY- That any amounts received, before or after such modification, during a single year by the enterprise as a draw on the commitment made by the Department of the Treasury under such an Agreement, shall be treated as a loan made by the Treasury to the enterprise that–

(A) was originated on the date of the last such draw during such year;

(B) has an original principal obligation in an amount equal to the aggregate amount of such draws;

(C) has a term to maturity of 30 years;

(D) has an annual interest rate of 5 percent for the entire term of the loan;

(E) has terms that provide for full amortization of the loan over such term to maturity; and

(F) shall be repaid by the enterprise in accordance with the amortization schedule established for the loan pursuant to subparagraph (E) of this paragraph, subject to paragraph (3).

(3) TREATMENT OF DIVIDENDS PAID- That any dividends paid by the enterprise to the Department of the Treasury under the Senior Preferred Stock Agreement before such modification of such Agreement shall be treated as payments of principal and interest due under the loan referred to in paragraph (2), and shall be credited against payments due under the terms of such loan (in accordance with the amortization schedule established for such loan pursuant to paragraph (2)(E)), first to such loan have the earliest origination date that has not yet been fully repaid until such loan is repaid, and then to the next such loan having the next earliest origination date until such loan is repaid.


For purposes of this Act, the following definitions shall apply:

(1) ENTERPRISE- The term `enterprise’ has the meaning given such term in section 1303 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4502).

(2) PREFERRED STOCK PURCHASE AGREEMENT- The term `Preferred Stock Purchase Agreement’ means, with respect to an enterprise, the Amended and Restated Senior Preferred Stock Purchase Agreements, dated September 26, 2008, amended May 6, 2009, further amended December 24, 2009, and further amended December 24, 2009 (as such agreements may be further amended), between the United States Department of the Treasury and such enterprise.


It is commendable that Congressman Capuano desires to do the right thing (he also serves on the House Committee on Ethics). His tenacity is equally impressive given that he is attempting to pass this bill again.

Does the bill have a chance of passing? Perhaps. But what will help is public support…!

What also helps is knowing that HERA 2008 required the financial agreements between Fannie/Freddie and the Department of Treasury to enable repayment.   REQUIRED!

Also, the Preferred Stock Purchase Agreement Stock Certificates between Fannie/Freddie and the US Treasury provides for the option for repayment.

The following is the section in HERA 2008 that discusses the repayment requirement:



(a)      FANNIE MAE.—Section 304 of the Federal National Mortgage Association Charter Act (12 U.S.C. 1719) is amended by adding at the end the following new subsection:



‘‘(A) GENERAL AUTHORITY.—In addition to the authority under subsection (C) of this section, the Secretary of the Treasury is authorized to purchase any obligations and other securities issued by the corporation under any section of this Act, on such terms and conditions as the Secretary may determine and in such amounts as the Secretary may determine. Nothing in this subsection requires the corporation to issue obligations or securities to the Secretary without mutual agreement between the Secretary and the corporation. Nothing in this subsection permits or authorizes the Secretary, without the agreement of the corporation, to engage in open market purchases of the common securities of the corporation.

‘‘(B) EMERGENCY DETERMINATION REQUIRED.—In connection with any use of this authority, the Secretary must determine that such actions are necessary to—

‘‘(i) provide stability to the financial markets;

‘‘(ii) prevent disruptions in the availability of mortgage finance; and ‘‘(iii) protect the taxpayer.

‘‘(C) CONSIDERATIONS.—To protect the taxpayers, the Secretary of the Treasury shall take into consideration the following in connection with exercising the authority contained in this paragraph:

‘‘(i) The need for preferences or priorities regarding payments to the Government.

‘‘(ii) Limits on maturity or disposition of obligations or securities to be purchased.

‘‘(iii) The corporation’s plan for the orderly resumption of private market funding or capital market access.

‘‘(iv) The probability of the corporation fulfilling the terms of any such obligation or other security, including repayment.

‘‘(v) The need to maintain the corporation’s status as a private shareholder-owned company.

‘‘(vi) Restrictions on the use of corporation resources, including limitations on the payment of dividends and executive compensation and any such other terms and conditions as appropriate for those purposes.

Click to access PLAW-110publ289.pdf


The Senior Preferred Stock Purchase Agreement, Preferred Stock Certificate dated September 17, 2012 and signed by Edward DeMarco provides for an option to repay the Treasury debt.




3. Optional Pay Down of Liquidation Preference

(a)    Following termination of the Commitment (as defined in the Preferred Stock Purchase Agreement referred to in Section 8 below), and subject to any limitations which may be imposed by law and the provisions below, the Company may pay down the Liquidation Preference of all outstanding shares of the Senior Preferred Stock pro rata, at any time, in whole or in part, out of funds legally available therefor, with such payment first being used to reduce any accrued and unpaid dividends previously added to the Liquidation Preference pursuant to Section 8 below and, to the extent all such accrued and unpaid dividends have been paid, next being used to reduce any Periodic Commitment Fees (as defined in the Preferred Stock Purchase Agreement referred to in Section 8 below) previously added to the Liquidation Preference pursuant to Section 8 below. Prior to termination of the Commitment, and subject to any limitations which may be imposed by law and the provisions below, the Company may pay down the Liquidation Preference of all outstanding shares of the Senior Preferred Stock pro rata, at any time, out of funds legally available therefor, but only to the extent of (i) accrued and unpaid dividends previously added to the Liquidation Preference pursuant to Section 8 below and not repaid by any prior pay down of Liquidation Preference and (ii) Periodic Commitment Fees previously added to the Liquidation Preference pursuant to Section 8 below and not repaid by any prior pay down of Liquidation Preference. Any pay down of Liquidation Preference permitted by this Section 3 shall be paid by making a payment in cash to the holders of record of outstanding shares of the Senior Preferred Stock as they appear in the books and records of the Company on such record date as shall be fixed in advance by the Board of Directors, not to be earlier than 45 days nor later than 10 days preceding the date fixed for the payment.

(b)    In the event the Company shall pay down of the Liquidation Preference of the Senior Preferred Stock as aforesaid, notice of such pay down shall be given by the Company by first class mail, postage prepaid, mailed neither less than 10 nor more than 45 days preceding the date fixed for the payment, to each holder of record of the shares of the Senior Preferred Stock, at such holder’s address as the same appears in the books and records of the Company. Each such notice shall state the amount by which the Liquidation Preference of each share shall be reduced and the pay down date.

(c)    If after termination of the Commitment the Company pays down the Liquidation Preference of each outstanding share of Senior Preferred Stock in full, such shares shall be deemed to have been redeemed as of the date of such payment, and the dividend that would otherwise be payable for the Dividend Period ending on the pay down date will be paid on such date. Following such deemed redemption, the shares of the Senior Preferred Stock shall no longer be deemed to be outstanding, and all rights of the holders thereof as holders of the Senior Preferred Stock shall cease, with respect to shares so redeemed, other than the right to receive the pay down amount (which shall include the final dividend for such shares). Any shares of the Senior Preferred Stock which shall have been so redeemed, after such redemption, shall no longer have the status of authorized, issued or outstanding shares.


Again, thanks to Congressman Capuano for his persistence and leadership in attempting to resolve the GSE quagmire. Mr. Capuano has HERA and the Agreements on his side. And he needs the public on his side, too!

Let’s rally behind Congressman Capuano’s effort to fix this stalemate and to restore hope in the American Dream!


Tim Howard January 2015


By Timothy Howard

There are two competing approaches to setting up a secondary mortgage market mechanism to succeed the one in place prior to the 2008 financial crisis: (a) legislative reform that would replace Fannie Mae and Freddie Mac with a de novo system, such as the one proposed by Senators Johnson and Crapo, and (b) administrative reform that would make structural and regulatory changes to Fannie Mae and Freddie Mac but keep them as the centerpieces of conventional secondary mortgage market financing.

The main argument for legislative mortgage reform is that Fannie Mae and Freddie Mac are a “failed business model” that needs to be replaced with a more reliable mechanism. But many proponents of this alternative, in defending it, badly distort the history of the financial crisis. In this paper we briefly discuss three important issues that are widely misunderstood or mischaracterized in the reform debate:

  • Treasury’s actions to place Fannie Mae and Freddie Mac into conservatorship were fundamentally different from Treasury and Federal Reserve interventions in support of commercial and investment banks during the financial crisis. Intervention in support of banks was done in response to sudden and uncontrollable liquidity crises that required immediate government assistance to keep the companies from failing, and involved actions and tools intended to achieve that result (not always successfully). The act of placing Fannie Mae and Freddie Mac into conservatorship was not a response to any imminent threat of failure but rather a policy decision initiated at a time of Treasury’s choosing, and involved actions and tools intended to make and keep the companies insolvent.
  • Convincing evidence exists that the conservatorships of Fannie Mae and Freddie Mac were planned well in advance, and that they were intended to remove the companies permanently from private ownership. There also is clear prior history of OFHEO and its successor agency FHFA following the dictates of Treasury in its dealings with Fannie Mae and Freddie Mac.
  • The motive behind the third amendment to the Treasury-FHFA senior preferred stock agreement was made evident by its timing, coming as it did just ten days after Fannie Mae announced sufficient second quarter 2012 earnings not only to pay its $2.9 billion quarterly senior preferred stock dividend but also to add $2.5 billion to its capital. Coupled with strong and growing revenues, rising home prices in the first half of 2012 meant that the pessimistic assumptions that had driven earlier decisions to write down assets, add huge amounts to the loss reserve, and establish a valuation reserve for deferred taxes no longer were supportable. Treasury and FHFA entered into to the third amendment to ensure that when many of these write-downs were reversed it would be the government, and not Fannie Mae’s shareholders, that would benefit.

The Fannie Mae takeover was unlike any other financial institution rescue

All of the individual financial institution rescues (or failures) during the 2008 crisis—including that of AIG—had similar profiles: market perceptions of a sharp decline in the value of a company’s mortgage-related assets led to rapid outflows of consumer deposits or an inability to roll over maturing short-term obligations. Depressed asset prices made it impossible for these highly leveraged companies to replace lost deposits or maturing short-term debt by selling assets without taking losses that would have exhausted their capital. The Federal Reserve and Treasury were faced with the need either to take immediate steps to save them—whether through assisted mergers, massive provisions of liquidity, asset guarantees or other measures—or to allow them to fail.

In their respective books, On the Brink and Stress Test, then-Treasury secretary Paulson and then-New York Federal Reserve president Geithner both discuss how the Fed and Treasury evaluated a financial institution in the throes of a liquidity crisis. If the long-term value of that company’s assets was too low to allow it to repay its outstanding debts, the company was insolvent and could not be saved without a permanent infusion of capital (typically by the government). If, on the other hand, the Fed and Treasury judged that the values of the company’s assets were only temporarily depressed—because, for example, markets had become illiquid—the Fed or Treasury could maintain its solvency by providing short-term loans or guarantying a floor value for their assets until their prices could recover.

Fannie Mae’s situation was totally different. In the winter of 2000, it had agreed with Treasury, and pledged publicly, to maintain sufficient liquidity to enable it to survive at least three months without access to the debt markets. As a consequence of this pledge—to which it had adhered—unlike all of the other companies rescued by the Fed or the Treasury during the crisis, Fannie Mae never experienced a threat to its solvency because of difficulty rolling over its maturing debt, nor did it need to sell assets at depressed prices to survive. The company never experienced a market crisis. At the time it was put into conservatorship, Fannie Mae’s capital significantly exceeded its regulatory minimum. Fannie Mae’s “rescue” was a policy choice by Treasury, with its timing determined by Paulson. As he said in On The Brink, he wanted to put Fannie Mae and Freddie Mac in conservatorship before Lehman Brothers announced a “dreadful loss” for the second quarter of 2008.

After the companies were placed in conservatorship, the mechanism Treasury used to extend credit to them—“draws” of non-repayable senior preferred stock to make up for book capital shortfalls—was one developed specifically for Fannie Mae and Freddie Mac. No other regulator in the world, at any time or under any set of circumstances, ever had used non-repayable senior preferred stock, paid with after-tax dollars, as a vehicle for rescuing a financial institution in crisis (or for any other purpose). The goal of this instrument was not to aid the two companies, but to push them into insolvency and keep them there.

The contrast between Treasury’s treatment of Fannie Mae and the banks during the financial crisis could not have been more striking. At the exact time the Fed and Treasury were making extraordinary efforts to overcome banks’ lack of liquidity by providing them with virtually unlimited assistance to bridge what they claimed was a period of temporarily depressed asset prices, Treasury was working with FHFA to make Fannie Mae’s superior liquidity irrelevant, by forcing it to mark down almost all of its assets, and change its accounting policies, to levels that reflected the same temporarily depressed values it was seeking to help the banks ride out through government assistance. Treasury then effectively made Fannie Mae’s temporarily depressed values permanent—foreclosing any chance of recovery, at any time—by requiring it to take draws of non-repayable senior preferred stock, at a 10 percent after-tax dividend, to fill the hole that Treasury and FHFA themselves had created.

It is difficult to look objectively at how Treasury responded to the real liquidity crises of the banks (and AIG) and at the same time created both the problems Fannie Mae (and Freddie Mac) faced and the unique “solution” to those problems, and conclude anything other than that Treasury took advantage of the 2008 financial crisis to advance their long-held policy objective of removing the two companies as the centerpieces of the U.S. mortgage finance system.

Treasury’s September 7, 2008 nationalization of Fannie Mae and Freddie Mac was planned well in advance

Treasury Secretary Paulson has said repeatedly that Treasury made its decision to place Fannie Mae and Freddie Mac under government control after the Housing and Economic Recovery Act (HERA) was signed on July 29, 2008, and only shortly before their conservatorships were announced. The facts, however, do not support that contention.

In late 2007, private-label securitization—which Treasury and the Federal Reserve had promoted aggressively since the early 2000s as superior to securitization by Fannie Mae and Freddie Mac for financing single-family mortgages—collapsed amidst an explosion of delinquencies and defaults. The result was in a huge fall-off in the supply of mortgage credit, to which Congress responded in February of 2008 by nearly doubling the Fannie Mae-Freddie Mac loan limit. That gave the companies access to the largest share of new residential mortgage loans in their history.

Within a month, in early March of 2008, a paper titled “Fannie Mae Insolvency and Its Consequences” was circulating among senior officials at the National Economic Council and the Treasury. This paper, which was provided to Barron’s as the basis for a negative article on Fannie Mae published on March 8, claimed that because of risky loan acquisitions and four accounting treatments it questioned—for deferred tax assets, low-income housing tax credits, and the valuation of both the company’s private-label security holdings and its guaranty obligations for mortgage-backed securities—Fannie Mae was in danger of failing and might have to be nationalized. Whatever one might have thought about the merits of the paper’s analysis, its prescription for Fannie Mae insolvency—writing down many of the company’s assets and greatly boosting its loss reserves—was a blueprint for what Treasury and FHFA would do six months later.

Barely a week after the Barron’s article, and on the eve of the announcement of the government-assisted acquisition of Bear Stearns by JP Morgan, Paulson overrode the strong objections of FHFA director Lockhart and agreed to allow Fannie Mae and Freddie Mac to reduce their surplus capital percentage with no firm commitment from either company to raise additional capital. This was significant on two levels—first as a clear example of Treasury’s dominance of FHFA, and second as a strong indication that Paulson at that early date already was thinking of Fannie Mae and Freddie Mac as instruments of the federal government. (Two years later, Paulson would tell the Financial Crisis Inquiry Commission, “[Fannie Mae and Freddie Mac], more than anyone, were the engine we needed to get through the problem.” [Emphasis added])

On July 11, the New York Times published a front-page article saying, “Senior Bush administration officials are considering a plan to have the government take over one or both of [Fannie Mae and Freddie Mac] and place them in a conservatorship if their problems worsen.” Shares of the companies plunged, and in response Paulson publicly pledged support for them on July 13, saying, “Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies.” Yet he had a very different private message for Wall Street insiders. As reported by Bloomberg in November of 2011, Paulson met with a select group of hedge fund managers at Eaton Park Capital Management on July 21, where he told them that Treasury was considering a plan to put Fannie Mae and Freddie Mac into conservatorship, which would effectively wipe out common and preferred shareholders. This, of course, is precisely what happened six weeks later.

When HERA was signed into law on July 29, it created a new regulator for Fannie Mae and Freddie Mac, FHFA (effectively, OFHEO renamed), and gave it expanded powers to put both companies into receivership or conservatorship. HERA also contained a clause not present in any other regulatory statute: “The members of the board of directors of a regulated entity shall not be liable to the shareholders or creditors of the regulated entity for acquiescing in or consenting in good faith to the appointment of the agency [FHFA] as conservator or receiver for that regulated entity.” The rationale for this clause became evident within a matter of weeks. When Paulson met with the directors of Fannie Mae and Freddie Mac to inform them of his intent to take over their companies, neither entity met any of the twelve conditions for conservatorship spelled out in the newly passed HERA legislation. Paulson since has admitted that he took the companies over by threat. Absent the unique provision in HERA exempting Fannie Mae’s and Freddie Mac’s directors from shareholder lawsuits for acquiescing in conservatorship, they may well have balked at Treasury’s demand that they allow the companies whose shareholders they represented to be taken over by the government without statutory cause.

Following the passage of HERA, Treasury asked the Fed, the Controller of the Currency and a Wall Street firm, Morgan Stanley, to assess Fannie Mae’s and Freddie Mac’s financial health. The weaknesses Treasury said they found in the companies’ capital and financial statements were nearly identical to the ones contained in the “Fannie Mae Insolvency and its Consequences” paper circulated six months earlier.   Treasury, however, lacked authority to put the two companies into conservatorship; only the new regulator, FHFA could do that. And Treasury had kept neither the old OFHEO nor the new FHFA apprised of its nationalization intentions. Paulson was unaware that on August 22 FHFA had sent both Fannie Mae and Freddie Mac letters saying the companies were safe and sound and exceeded their regulatory capital requirements. Paulson told Lockhart that he had to change his agency’s posture on the two companies, and FHFA did exactly that. On September 4, FHFA sent each company an extremely harsh mid-year review letter, and two days later, Paulson, Lockhart and Fed chairman Bernanke met with the companies’ CEOs and directors to tell them they had no choice but to agree to conservatorship.

On the day Fannie Mae and Freddie Mac were put into conservatorship, Treasury and the conservator, FHFA, “agreed” to a one-sided and punitive senior preferred stock agreement that wiped out nearly all of the value of shareholder investments in the companies’ common and preferred stock. Shortly thereafter, FHFA as conservator implemented the accounting write-downs identified in the “Fannie Mae Insolvency and its Consequences” paper, along with others, to exhaust Fannie Mae’s capital and create a need to take non-repayable senior preferred stock from Treasury, at a 10 percent dividend. Cumulative borrowings of this stock ultimately reached $117.1 billion before the company could return to profitability in 2012.

The third amendment to the senior preferred stock agreement was adopted to prevent Fannie Mae from benefiting from the reversal of extremely conservative accounting decisions made earlier

At a surface level, it appeared that Fannie Mae had no chance at any time in the foreseeable future of paying an $11.7 billion annual after-tax senior preferred stock dividend to Treasury and having anything left over as retained earnings. Doing so would have required pre-tax earnings of more than $18 billion, and the most pre-tax net income the company ever earned had been $11.4 billion, in 2003. Moreover, as part of the 2008 senior preferred stock agreement Fannie Mae had been required to shrink its mortgage portfolio—the source of a majority of the company’s earnings—by ten percent per year. Yet the strategy devised by Treasury to push Fannie Mae into insolvency contained the seeds of its own undoing, giving rise to the need for a third amendment to the senior preferred stock agreement in 2012.

To understand what happened, it is useful to think of Fannie Mae’s earnings as having three basic components: (a) revenues from the company’s two businesses, portfolio investments and credit guarantees, (b) annual expenses, principally administrative costs and credit losses, and (c) accounting gains or losses.

During the eight years between 2003 and 2011, the combined revenues from Fannie Mae’s portfolio investments and credit guarantees grew irregularly but strongly, rising by almost 60 percent. The $162 billion in losses the company recorded from 2008 through 2011 was not due to a lack of revenue. Indeed, the $74 billion Fannie Mae booked in combined net interest income from its mortgage portfolio and guarantee fees from its mortgage-backed securities during the 2008- 2011 period was more than enough to cover not only the huge $62 billion spike in its actual credit losses (charge-offs net of recoveries, plus foreclosed property expense) but also its cumulative $9 billion in administrative expenses during that time. Put another way, all of Fannie Mae’s GAAP losses from 2008 through 2011 stemmed from accounting entries and judgments: principally the exceptionally large $70 billion increase in its reserve for future loan losses, and significant write-downs of a number of items on the company’s balance sheet (which are not possible to calculate precisely because of the complexity of Fannie Mae’s GAAP accounting).

Many of the write-downs were made near the low points of asset values and were subject to upward revision in future periods, while the loss reserve similarly was predicated on pessimistic projections of future home prices, loan defaults and loss severities. The turning point for both sets of accounting decisions came during the first half of 2012. After falling by almost 24 percent from the third quarter of 2006 to the first quarter of 2012, Fannie Mae’s index of home prices rose by 3.2 percent in the second quarter of 2012. This jump in home prices, together with a sharp rise in the prices received for sales of foreclosed homes and a further decrease in Fannie Mae’s single-family serious delinquency rate, convinced the company that it could begin to use its ample loss reserve to absorb current-period credit losses. Doing so meant that nearly all of Fannie Mae’s $5.8 billion in pre-tax revenues reached its bottom line in the second quarter, since tax loss carry-forwards made its federal income tax liability zero. The company was able to make its $2.9 billion quarterly dividend payment to Treasury and still add $2.5 billion to its net worth.

With a positive net worth, strong revenues, a declining loss reserve, the tax loss carry-forward, and the likelihood of upward asset price revaluations and the successful resolution of loan repurchase claims over the next several quarters, it suddenly became apparent that Fannie Mae would not need any further draws from Treasury for quite a long period of time. And if that were the case, the decision Treasury and FHFA had made in 2008 to establish a valuation reserve for Fannie Mae’s deferred tax assets soon would be reversed, adding even further to the company’s profits, retained earnings and capital.

Treasury, of course, knew all this; it was the one that had engineered Fannie Mae’s accounting losses and excessive loss reserving in the first place, following the roadmap of the March 2008 paper, “Fannie Mae Insolvency and its Consequences.” Treasury and FHFA agreed to the third amendment to the senior preferred stock agreement—in which Fannie Mae and Freddie Mac would be required to give all of their future profits to Treasury instead of paying a quarterly preferred stock dividend—so that the government, and not the company’s shareholders, would reap the benefits of the now-imminent reversal of many of the earlier accounting-related write-downs.

It was even less difficult for Treasury to get FHFA to agree to the third amendment in 2012 than it had been in 2008 getting director Lockhart to agree to reduce Fannie Mae and Freddie Mac’s surplus capital percentage, or to reverse his previous public position that the companies were safe and sound and adequately capitalized. In 2012 the acting director of FHFA was Ed DeMarco, who from 1993 to 2003 had worked at Treasury as director of the Office of Financial Institutions Policy.

Treasury insists that the third amendment was essential to prevent the companies from having to undertake an endless cycle of borrowing in order to continue to make their dividend payments. But with the third amendment coming only after Fannie Mae had begun to rebuild its capital—and with the reversal of its reserve for deferred tax assets having become a virtual certainty—this rationale crumbles in the face of the factual record.

A way forward

The argument for bringing Fannie Mae and Freddie Mac out of conservatorship and using an amended version them as the basis of the future mortgage finance system is extremely straightforward: their credit guaranty mechanism is low-cost, efficient and effective, and has a proven track record of success. There is no credible basis for the oft-repeated contention that they are a “failed business model.” Even after Fannie Mae and Freddie Mac made unwise decisions to lower their underwriting standards to try to compete with private-label securitization, their loans acquired between 2005 and 2008 still performed four times as well as loans from that period financed through private-label securities, and more than twice as well as loans made and retained by commercial banks during that time.

The false narrative about the two companies’ problems and the government’s role in intervening in their affairs now hampers the effort to design a robust system for the future. Each of the major legislative reform proposals—the Hensarling bill in the House, and the Corker-Warner and Johnson-Crapo bills in the Senate—starts with the assumption that the system of the future should look nothing like the “failed” Fannie Mae and Freddie Mac did in the past. That has led drafters of these efforts to rule out structures, techniques and elements that have demonstrated records of success, in exchange for more complex and unproven approaches. There is an understandable reluctance on the part of Congress to risk the functioning of a $10 trillion credit market crucial to the nation’s economy on an untested alternative.

The remaining objection to preserving Fannie Mae and Freddie Mac is political, but even that political argument weakens when examined closely. The companies’ longstanding critics, including the Treasury and the Federal Reserve, based their historical opposition on the portfolio business, and the agency debt that funded it. Right up until the time the mortgage finance system imploded, there was very little criticism of Fannie Mae and Freddie Mac’s credit guaranty activities.

Ironically, Treasury now holds the key to administrative reform of the system. FHFA cannot release Fannie Mae and Freddie Mac from conservatorship as long as the third amendment remains in force, because with Treasury keeping all of their earnings the two never could be viable as private companies.

There is a simple solution that will break the impasse. Treasury should declare victory in their battle against the “old” Fannie Mae and Freddie Mac. No one is arguing for the restoration of the companies’ on-balance sheet portfolio business, funded by agency debt, while their credit guaranty business helps banks originate fixed-rate mortgages without taking on unmanageable interest rate risk. Treasury’s insistence on “killing the ghosts” of two companies that no longer exist is the single biggest impediment to mortgage reform. Treasury needs to accept the fact that they have beaten the Fannie Mae and Freddie Mac they once found so objectionable, put that fight behind them, and turn their attention to helping to build a mortgage finance system for the twenty-first century. This would include replacing the third amendment to the senior preferred stock agreement—which was designed to keep Fannie Mae and Freddie Mac insolvent—with a fourth amendment designed to allow them to be released from conservatorship and returned to private ownership, limited to the credit guaranty business, with more capital and stronger oversight, and with the proven ability to provide the volumes of fixed-rate mortgages homebuyers require, at a cost they can afford.

Timothy Howard was a senior executive at Fannie Mae for 23 years, starting as chief economist in March 1982 and holding a number of positions until leaving as vice chairman and chief financial officer in December 2004. His book on the financial crisis, The Mortgage Wars, was published in November 2013.

January 11, 2015

Warren and Cummings: Free the Middle Class

Call them by their proper titles: Legislative BadassesMSNBC: Sen. Elizabeth Warren and Rep. Elijah Cummings join Morning Joe to announce their new push for the middle class.


Middle income working families are falling behind, trapped in debt, searching for opportunity.

USA Today

By Elizabeth Warren and Elijah Cummings

February 23, 2015

America is recovering from the Great Recession. The stock market and corporate profits are at all-time highs. Worker productivity is skyrocketing. Unemployment is falling. Inflation remains low. The deficit is shrinking and many families have health insurance for the first time.

Good news — but not the whole story. Millions of Americans are working harder than ever and still falling behind. Deep structural changes in our economy over the past several decades have undermined the ability of millions of people to build a secure future.

For more than 30 years, America’s middle class has been hammered. For those not occupying corner offices or able to fall back on investment portfolios, incomes have stagnated while expenses have increased, forcing tens of millions of people into debt just to make ends meet .

Things haven’t always been this way.

From the end of the Great Depression to about 1980, America built a middle class unlike anything known on earth. As the economy grew, income and family wealth grew. Families bought homes and cars, took vacations, educated their children and saved for retirement. This spurred demand for consumer goods and housing, combining to build one of the most unprecedented periods of growth in American history.

But then things changed. Beginning in the late 1970s, corporate executives and stockholders began taking greater shares of the gains. Productivity kept going up, but workers were left behind as wages stagnated.

Families might have survived as their incomes flattened, except for one hard fact: the costs of basic needs like housing, education and child care exploded. Millions took on mountains of debt and young people began struggling to cling to the same economic rung as their parents.

After the 2008 economic collapse, massive financial institutions received billions of dollars in bailouts, while families across the country watched helplessly as their home values and savings crashed and millions of jobs disappeared.

These events were not caused by an invisible hand. They were not the inevitable result of globalization or organic market trends. Instead, powerful interest groups, massive corporations and the super-rich rigged the system to jack up their profits and grab the spoils for themselves.

For too long, government has worked for the rich and powerful. Government needs to work for America’s middle class again.

America’s middle class is about opportunity. People create their own opportunity: they work hard, get an education and make smart decisions. But government also plays a role. Investments in schools give people a chance to get an education. Investments in infrastructure like roads and bridges, power grids and communications networks make it more profitable to create jobs here at home. Investments in medical and scientific research provide the foundations for an innovation economy. We do it on our own AND we do it together.

Opportunity is also about a level playing field. A tax code riddled with special interest loopholes that taxes the wages of assembly line workers and teachers at higher rates than the capital gains of billionaire hedge fund investors is not on the level. It just means that the rich get richer, and everyone else picks up the tab.

Under President Obama, the country has been digging out of the Great Recession. We’ve made great strides based on policies that Democrats have championed. But we must do more.

That’s why this week we’re launching a new Middle Class Prosperity Project to give a voice in Washington to those who need it most — hard-working people across this country. On Tuesday, we will hold the first in a series of forums to examine economic policies threatening the middle class, and we’ll hear from leading economists about how to help families rebuild economic security.

After the Great Depression, Congress enacted progressive policies to build and expand the middle class. But Washington became captive to powerful interests that game the system at the expense of the middle class.

It’s time to change that system. We must free our government from the grip of armies of lobbyists and the corruption of corporate influence.

This is one of the most urgent issues this generation faces. So we’ll work together to do what Congress should be doing — promoting policies to ensure that the best days of America’s middle class are still ahead.

Senator Elizabeth Warren is the Ranking Member of the Senate Subcommittee on Economic Policy, and Congressman Elijah Cummings is the Ranking Member of the House Committee on Oversight and Government Reform.

Click to access EEC%20Opening%20Statement%20-%20MCPP%20Forum.pdf

Click to access White%20Paper%20on%20Survey%2002-24-15_0.pdf

CMLA calls on FHFA, Treasury to recapitalize Fannie and Freddie

Trey Garrison

February 23, 2015

The Community Mortgage Lenders of America renewed its call for U.S. Treasury Secretary Jack Lew and Federal Housing Finance Agency Director Mel Watt to take immediate action to recapitalize/cure the under-capitalization of both Fannie Mae and Freddie Mac.

The CMLA in December of last year – as the GSEs were reporting record profits – called for immediate action that would allow them to retain some of those profits to build a reasonable risk capital base.

Now, as profits plummet for both Fannie Mae and Freddie Mac – due in large part, to losses on derivatives – that call gains prophetic urgency.

The GSE capital levels, already minimal, will hit zero within just the next few years. Low or zero capital, coupled with declining earnings, could require yet another federal bailout. Fannie’s CEO Tim Mayopoulos, for example, said the “fact that we don’t have a significant amount of capital increases the likelihood” that Fannie will need additional capital from Treasury at some point.

The GSE capital depletion is a direct outcome of the repayment terms embedded in the Preferred Stock Purchase Agreements between the GSEs and the U.S. Treasury. That agreement requires the GSEs to remit 100% of profits, which precludes building capital.

CMLA Chair Paulina McGrath said “this precarious balance in earnings, derivative and market risks versus capital is an irrational approach to preserving the housing market. The Treasury agreement generates cash flow into the Federal coffers but this could prove to be at the expense of lenders and homebuyers alike.”

After Freddie Mac makes its next dividend payment, the GSE will have returned $91.8 billion to Treasury versus draws of $72.3 billion, resulting in an account surplus of $19.5 billion.

Both GSEs have recorded 12 consecutive profitable quarters while, at the same time, each is approaching zero capital levels. That leaves the GSEs – and in turn, the taxpayers – at risk from market or overall economic declines as well as continued losses from GSE derivatives.

The CMLA is repeating its call for Treasury to take immediate corrective action to cure the undercapitalization of the GSEs.

“There is neither a need nor a rational reason to wait on Congress to act, particularly since GSE reform legislation is far from certain,” McGrath said.

Dusting Off FIRREA: Old Statute Is Now Potent Weapon

Law360, New York (February 12, 2015, 10:52 AM ET)

A long-dormant law can become an unexpectedly potent weapon in the hands of an assertive prosecutor. And in recent years, few statutes have undergone a rebirth more dramatic — and for some, more troubling — than the civil penalties provision of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. 12 U.S.C. § 1833a.
Enacted in response to the savings and loan crisis but scarcely used over the following two decades, FIRREA has become a favored tool for prosecutors in the aftermath of the recent financial crisis. FIRREA offers prosecutors unusual and powerful advantages, which have only been amplified by the U.S. Department of Justice‘s aggressive interpretations of the statute — interpretations that have, so far, enjoyed a friendly reception from the courts.

In a nutshell, FIRREA authorizes the DOJ to impose civil financial penalties for violations of 14 enumerated criminal statutes. Some of these predicate statutes specifically penalize conduct injuring financial institutions; others sweep more broadly, but only become FIRREA predicates when the defendant’s conduct “affect[s] a federally insured financial institution.”

FIRREA’s hybrid civil-criminal structure gives the DOJ important advantages in developing and litigating FIRREA cases — advantages that are not available under other federal statutes. For example, the DOJ can recover penalties for violations of predicate criminal statutes that it proves by a preponderance of the evidence — not necessarily beyond a reasonable doubt. FIRREA also provides a 10-year statute of limitations — twice the time generally available for federal criminal statutes. And the DOJ can compel production of documents and testimony using administrative subpoenas.

For defendants in FIRREA actions, the potential exposure can be significant. As a general matter, the statute imposes penalties up to $1.1 million (or, for a continuing violation, the lesser of $1.1 million per day or $5.5 million). But — of critical importance in financial crisis cases involving large financial institutions — penalties also can reach the amount of “gain” or “loss” if “any person derives pecuniary gain from the violation, or if the violation results in pecuniary loss to a person other than the violator.”

Thus, in a case that awaits appeal, United States ex rel. O’Donnell v. Countrywide Home Loans Inc., 12-cv-1422 (JSR) (S.D.N.Y. July 30, 2014), ECF 343, Judge Jed S. Rakoff imposed a $1.3 billion penalty against Bank of America and Countrywide Financial Corp. after a jury verdict of liability. Meanwhile, in the span of less than a year, the DOJ announced a string of massive FIRREA settlements, including a $13 billion settlement with JPMorgan Chase, a $7 billion settlement with Citibank and an over $16 billion settlement with Bank of America.

In pursuing FIRREA cases, the government has advocated — often with success — expansive interpretations of the statute. Among other things, it has urged that a violation of a predicate criminal statute can “affect[] a federally insured financial institution” even when the alleged wrongdoing of the defendant (which is a financial institution) did not appear to target any other financial institution, but imposed litigation costs and reputational harms on the defendant itself. Three district judges in the Southern District of New York have endorsed this self-affecting reading of FIRREA. See United States v. Bank of N.Y. Mellon, 941 F. Supp. 2d 438, 451 (S.D.N.Y. 2013); United States v. Wells Fargo, 972 F. Supp. 2d 593, 629-30 (S.D.N.Y. 2013); United States v. Countrywide Fin. Corp. et al., 961 F. Supp. 2d 598, 604-05 (S.D.N.Y. 2013).

The government also has pushed the boundaries of FIRREA’s predicate criminal statutes. For example, in a FIRREA case brought in the Western District of North Carolina, the DOJ alleged that a prospectus supplement for a securities offering by Bank of America contained material misstatements. Complaint, United States v. Bank of Am. Corp., 13-cv-446 (W.D.N.C. Aug 6, 2013), ECF No. 1.

But violations of securities laws are not a FIRREA predicate, so the DOJ alleged instead violations of the federal false statements statute, and a statute prohibiting fraud in loan and credit applications. 18 U.S.C. §§ 1001, 1014. The strategy raised significant questions about the incursion on the securities laws by the (FIRREA-enhanced) application of general false-statement statutes — questions only exacerbated by the fact that the U.S. Securities and Exchange Commission brought its own action against Bank of America based on the same conduct. Complaint, SEC v. Bank of Am., N.A., 13-cv-447 (W.D.N.C. Aug. 6, 2013), ECF No. 1.

No less important than the scope of FIRREA offenses is the extent of the penalty the DOJ may seek. In that regard, Judge Rakoff’s decision in United States ex rel. O’Donnell offers little comfort to FIRREA defendants.

In calculating the pecuniary “gain” or “loss” from a purported misrepresentation of the underwriting process for mortgages purchased by Fannie Mae and Freddie Mac, Judge Rakoff calculated the maximum FIRREA penalty based on the full sales price of the mortgages — not on a share of that price directly attributable to the misrepresentation. This makes revenue, rather than purportedly unlawful profit, the measure of “gain.” Similarly, Judge Rakoff declined to consider whether purchasers’ “loss” resulted from the supposed misrepresentation or from exogenous declines in home values.

None of this is good news for prospective FIRREA defendants. The procedural advantages the statute affords the DOJ are formidable. And the DOJ’s expansive interpretations of the statute will be hard for defendants to test in appellate courts — not least because the threat of astronomic penalties encourages early settlements of FIRREA cases. So, while the statute’s precise scope remains uncertain, the DOJ has undoubtedly dusted off a powerful not-so-new enforcement tool against financial institutions.

—By Boris Bershteyn and John K. Carroll, Skadden Arps Slate Meagher & Flom LLP

Boris Bershteyn is a partner in Skadden’s New York office. He is a former general counsel of the Office of Management and Budget and has served as special assistant to President Barack Obama and associate White House counsel.

John Carroll is a partner in New York and formerly served as the chief of the Securities and Commodities Fraud Task Force in the Southern District of New York. He also was a member of the U.S. Attorney General’s Economic Crimes Council and the U.S. Department of Justice’s Securities and Commodities Fraud Working Group.

This article is from Skadden’s 2015 Insights.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.