Guns N’ Roses – Sweet Child O’ Mine

She’s got a smile it seems to me

Reminds me of childhood memories
Where everything
Was as fresh as the bright blue sky
Now and then when I see her face
She takes me away to that special place
And if I’d stare too long
I’d probably break down and cry

Oh, oh, oh
Sweet child o’ mine
Oh, oh, oh, oh
Sweet love of mine

She’s got eyes of the bluest skies
As if they thought of rain
I hate to look into those eyes
And see an ounce of pain
Her hair reminds me of a warm safe place
Where as a child I’d hide
And pray for the thunder
And the rain
To quietly pass me by

Oh, oh, oh
Sweet child o’ mine
Oh, oh, oh, oh
Sweet love of mine

Oh, oh, oh, oh
Sweet child o’ mine
Oh, oh, oh, oh
Sweet love of mine

Oh, oh, oh, oh
Sweet child o’ mine
Oh,
Sweet love of mine

Where do we go?
Where do we go now?
Where do we go?
Oh, oh
Where do we go?
Oh,
Where do we go now?
Where do we go?
Oh, (sweet child)
Where do we go now?
Oh,
Where do we go now?
Oh,
Where do we go?
Oh,
Where do we go now?
Oh,
Where do we go?
Where do we go now?
Where do we go?
Oh,
Where do we go now?
No, no, no, no, no, no
Sweet child,
Sweet child of mine

Steve Mnuchin

As most of us know by now, Steve Mnuchin announced the Trump Administration’s intention to end the conservatorship of Fannie and Freddie during an interview on Fox News on November 30 seen here: https://youtu.be/WAFLne-LRxw

The results were likely predictable – stock prices rose and Mnuchin was attacked by the opposition. Many articles ran in the big bank-influenced media soon after, including one in the WSJ titled, Mnuchin Has Stake in Fund That Would Gain From Fannie Mae Revival.

The attack against Mnuchin was simple – the only reason he stated the eight year long conservatorships must end was his desire to enrich his friends and himself.

During his confirmation, in response to the attacks, Mnuchin preemptively stated his opinion on Fan/Fred was based on his decades-long experience in the mortgage industry (and not motivated by potential personal gain) as seen here: https://youtu.be/KySH-n7TbKE?t=3m34s

The Senate Finance Committee is set to hold an Executive Session tomorrow at 6:00 PM EST to consider endorsing Mnuchin’s nomination. Orrin Hatch, committee chairman, stated:

“Committee members and the American people heard a strong case from Steven Mnuchin on why he should be Treasury Secretary,” Hatch said. “His seasoned career as a financial leader equip him with the ability to steer the American economy in the right direction. And his commitment to work with Congress to reform our outdated tax code and explore ways to improve our nation’s broken infrastructure system should garner the support of my colleagues on both sides of the aisle. I look forward to the Committee voting on his nomination.”

The long-awaited beginning of the end of Fanniegate is finally here…

WILY WILLIAM I$AAC

Seems like “expert opinion” can be swayed by the highest bidder.

Yesterday, William Isaac, former chairman of the Federal Deposit Insurance Corporation, teamed with Richard Kovacevich, a retired chairman and CEO of Wells Fargo & Co.

The two penned an OpEd that ran in the Wall Street Journal: Winding Down Fannie and Freddie Is Easier Than It Seems.

In the piece, the former bank regulator and former banker state:

“No other country has the equivalent of the private-public model of Fannie Mae and Freddie Mac—crony capitalism at its best.

The solution is straightforward: The public-private hybrid of Fannie and Freddie—“government-sponsored entities”—should be abolished, their existing business sold or liquidated, and the mortgage market privatized. This can be done in a few easy steps.

The current $686,000 cap on new mortgages guaranteed by Fannie and Freddie should be reduced by $100,000 a year. This would put the companies out of originating new mortgages within seven years.”

Messrs. Isaac and Kovacevich are evidently calling for the elimination of Fannie Mae and Freddie Mac. This recommendation from Mr. K is not at all surprising because the TBTF banks have been circling Fan/Fred like crazed vultures ever since the US Government seized the two companies.

However, Mr. Isaac seems to have a new — and completely different — outlook on Fannie and Freddie. Perhaps, FTI Consulting (Isaac’s employer) has a new client that wants to see the demise of Fan/Fred.

What’s odd is the 180 degree, about-face…

In April 2015, Mr. Isaac co-wrote with former senator Bob Kerrey, How The Fannie Mae, Freddie Mac Conservatorship Has Undermined The Resolution Process.

In this article they state:

“By diverting all profits away from the GSEs, FHFA effectively precluded any ability of the companies to boost their capital levels and over time “earn” their way out of conservatorship. Moreover, the profit sweep contradicts FHFA’s mandate to “preserve and protect” enterprise assets and property.

Such public-private partnerships at times of crisis require consistency in the federal government’s respect for, and protection of, private property rights. No private party will put capital at risk if they think the government can take it away from them in conservatorship or bankruptcy, however noble the underlying policy goals or inspiring the associated political rhetoric.

But the conservatorships have left the enterprises in a state of suspended animation; neither private nor public entity and yet their business must continue. The government’s decision to violate HERA in 2012 by invoking the so-called “profit sweep” has deprived the GSEs of their ability to rebuild capital and has put taxpayers at greater risk. It also undermines the government’s role in times of future crisis. If private capital can’t count on the rule of law, it won’t participate in the future and taxpayers will have to pick up the pieces of what’s left of the financial system.”

Earlier this year in February, Mr. Isaac wrote, U.S. Government Must Make a Decision on Freddie, Fannie.

Comments include:

“This action by the Administration created the worst of all worlds. Instead of trying to restore the companies to health, as HERA requires, the government’s actions stripped Fannie and Freddie of all their capital. The result: They again pose a substantial risk to taxpayers.

When faced with litigation and demands from the public to know why it took this action, the government initially told the courts that the profit giveaway was intended to save the companies and avoid an upcoming “death spiral.” But documents released in litigation have proven that assertion to be false. The truth, it seems, is that the profit giveaway was intended to facilitate the companies’ demise while providing windfall profits for the Treasury. As former Treasury Secretary Geithner colorfully testified, the government actually wanted to dismember the companies.

Even to a layperson, dismemberment does not heed the mandate of a conservator to restore the companies to sound condition and preserve their assets.

By the FHFA’s own admission and the government’s newly concocted litigation rationale, the government’s goal in stripping the companies of future profits was to fill the government’s coffers while ushering in the demise of Fannie and Freddie. But despite its supposed intent to wind the companies down, the government is keeping them alive and stripping them of all of their capital. This is incompatible with both current law and millennia of conservatorship history.

While taxpayer protection may sound good, it does not relieve the FHFA of its legal obligations to place the companies in sound condition, preserve their assets, and restore them to normal operations.”

$omething must have happened between February and December that Mr. I$aac would go from saying, “restore them to normal operations” to “should be abolished.”

One wonder$ what motivate$ $omeone to change their “expert opinion” so dra$tically, so $wiftly…

“If you don’t read the newspaper…

…you’re uninformed. If you read the newspaper, you’re misinformed.” Mark Twain

If you’ve followed Fanniegate for some time, you’re well aware that any time anything positive happens relating to Fannie and Freddie there will invariably be a negative article or response by a) a “journalist,” b) an “industry expert” or c) by a paid-for politician.

All of these folks have one thing in common; they do not want to see Fannie and Freddie succeed.

The “journalists” either work for a company that has taken a political/financial position (advocacy journalism) or some of these reporters are motivated by their ability to gain access to high government officials to interview for their articles… providing the reporters write the news (spin) in the officials’ favor (access journalism).

Oftentimes the “industry experts” are merely promoting the position for their clients…plain and simple.

Bought politicians are even easier to understand…

For those of you that are relatively new to Fanniegate, it is important to know that there are credible, respected people on the other side of the discussion.

One of these people is Gretchen Morgenson, Pulitzer Prize-winning financial reporter from the New York Times. Gretchen was the first mainstream media reporter to write an unbiased article on Fanniegate.

In February 2014, Gretchen wrote “The Untouchable Profits of Fannie Mae and Freddie Mac” which effectively broke the silence with major media. In this article, she highlighted the discovery of a secret government memorandum that outlined their plan to undermine shareholders:

“Furthermore, nationalization would have required the government to provide compensation to shareholders for what it took. Now the government gets the benefits of the companies’ profits while avoiding any compensation payments.”

Gretchen even made news when she addressed the issue of access journalism in a presentation at the 2015 Page One Awards:

“My second issue is closer to home — and it concerns the state of journalism today. That is, the rise of access journalists — those whose stories help their hidden sources promote themselves and their views — and the decline in accountability journalists. These are the folks who seek to hold powerful people responsible for their actions. Who, as the saying goes, seek to afflict the comfortable and comfort the afflicted.”

Gretchen’s presentation at this awards ceremony even addressed Fanniegate with her acknowledgement of unusual circumstances of the government secrecy:

“In response to the lawsuit, the government has demanded an extreme level of secrecy surrounding documents the judge has ordered it to produce. Those documents would shed light on how the decision to divert the profits was made, an important question given that the 2008 law written by Congress to handle the company’s problems was supposed to stabilize them and let them build up capital after the crisis receded.”

Gretchen is the lead, major journalist that has written the most articles regarding the saga involving Fannie Mae and Freddie Mac. Highlights of Gretchen’s articles are as follows:

December 2015: “Fannie and Freddie’s Government Rescue Has Come With Claws:”

“The August 2012 profit sweep surprised investors, but documents show that it came long after Treasury officials had indicated privately that they wanted to ensure Fannie and Freddie shareholders would receive none of the companies’ future profits.”

April 2016, “Documents Undercut U.S. Case for Taking Mortgage Giant Fannie Mae’s Profits:”

“Further testimony unsealed on Monday came from Mario Ugoletti, a former Treasury official who was a former special adviser to the director of the Federal Housing Finance Agency, the conservator overseeing Fannie and Freddie.

In December 2013, Mr. Ugoletti signed an affidavit for the case stating unequivocally that neither the Treasury nor the Federal Housing Finance Agency envisioned that the companies’ deferred tax assets were about to be reversed in the months leading up to the profit sweep, generating huge profits. He also said that the move was not intended to “increase compensation to Treasury.”

 But in the deposition in May, Mr. Ugoletti said he did not know whether the Treasury or the Federal Housing Finance Agency officials knew about the potential for the profits at Fannie and Freddie at the time of the sweep.

Mr. Ugoletti, who left government in the fall could not be reached for comment”.

May 2016, “Fannie, Freddie and the Secrets of a Bailout With No Exit:”

“An email from Jim Parrott, then a top White House official on housing finance, was sent the day the so-called profit sweep was announced. It said the change was structured to ensure that the companies couldn’t “repay their debt and escape as it were.”

The documents also show the Treasury moving to modify the terms of the mortgage finance giants’ $187.5 billion bailout shortly after a July 2012 meeting when the Federal Housing Finance Agency, Fannie’s and Freddie’s regulator, learned that they were about to enter “the golden years” of profitability.

October 2016, “Fannie and Freddie Investors Win Round in Suit Against U.S.:”

“The government initially argued that it acted to protect taxpayers from future losses because the companies were in a death spiral, but the decision to funnel the profits into the Treasury’s general fund came just before Fannie and Freddie returned to profitability.”

December 2016, “Trump Treasury May Mean Independence for Fannie and Freddie:”

“When the government changed the terms of their bailouts in the summer of 2012 and began expropriating all of Fannie’s and Freddie’s profits every quarter, it seemed as if that unsatisfactory setup would go on forever. After all, it is hard for the government to give up a honey pot that has returned over $60 billion more to the Treasury than the companies received from taxpayers during their troubles.” 

If Judge Sweeney were to order the release of more documents, the current administration would probably appeal. It is not as clear that a Trump administration would do so, however. This opens the possibility that all those materials that the Obama administration has fought so hard to keep secret might just emerge.

That would be a huge service for anyone interested in holding government officials accountable for their actions.”

The following articles and highlights were also written by credible journalists:

Matt Taibbi, Rolling Stone magazine, “Why Is the Obama Administration Trying to Keep 11,000 Documents Sealed?”

“Are the gory details of that plan what the government is working so hard to keep under seal?

We may never know. Judge Sweeney has yet to rule on the vast majority of the documents, and there’s no guarantee that she will ultimately unseal the remainder of the material. We may never find out what the government was so keen on keeping secret.

The only thing that is clear is that there’s something odd going on, with the Obama administration asserting privilege over a volume of papers so large, it would make Nixon blush.”

Roger Parloff, Fortune Magazine: “How Uncle Sam Nationalized Two Fortune 50 Companies:”

“Yet on Aug. 17, 2012—about 10 days after the terrific second-quarter results were announced—something singular happened. For reasons that remain shrouded in secrecy to this day, the Treasury Department and the companies’ conservator, the Federal Housing Finance Agency (FHFA)—two arms of the same government—agreed to radically change the terms of what the GSEs would owe in exchange for the moneys they had already received.

If this strikes you as, well, un-American, you’re not alone.”

Bethany McLean, “Mend, Don’t End, Fannie and Freddie:”

“Rhetoric aside, conservatorship is supposed to be governed by the law, which in essence says that the conservator must either “preserve and conserve” the GSEs and release them back, or throw them into receivership, in which case their assets would be distributed to shareholders. The investors argue that even a few years after the crisis, there were sufficient assets that the preferred stockholders would have gotten all the money they were owed.

But then on August 17, 2012, a sleepy summer Friday, Treasury and the FHFA changed the rules of the game. Going forward, instead of paying a 10 percent dividend, Fannie and Freddie would be required to send every penny they made to Treasury. If everything went to the government, then there was no value left for investors. Both the common and the preferred shares plunged in price.

The official explanation for this change is that the administration had no idea that the GSEs were about to become so wildly profitable, and so they executed the sweep of profits to prevent the GSEs from owing money they couldn’t pay. The sheer amount of money the GSEs started making immediately following the sweep makes it hard to believe this.”

Attorneys that specialize in these issues have also commented:

Richard Epstein, NYU School of Law, has written several articles on the subject including:

“Untangling the GSE Foolishness: The D.C. Circuit Should Upend Treasury’s Net Worth:”

“But no matter which route the transaction takes, the private shareholders are entitled to have a hearing to determine the size of their residual interest under the most elementary principles that insist that no property can be taken without the hearing required as a basic matter of procedural due process.

So the deal is really simple. Treasury took all residual shares for a zero price, and now pleads its own poverty as a defense.”

In a previous blog post here, I highlighted the many articles by Tara Helfman, Yale Law School graduate and Associate Professor at Syracuse University College of Law.

Logan Beirne, Fulbright Scholar and Yale Law School graduate: “Have FHFA and the Treasury Exceeded Their Limited Authority under HERA?”

“However, rather than work as conservator to benefit Fannie Mae and Freddie Mac’s shareholders, as is its obligation under traditional conservatorship law, the FHFA acted for the benefit of the U.S. government – and to the detriment of those private shareholders. In a surprise deal, the FHFA effectively wiped out the private shareholders and essentially turned the proceeds of Freddie and Fannie to the U.S. Treasury.”

Additional industry specialists wrote several articles including the following by Glen Corso and Josh Rosner:  “Why it’s Time for True GSE Reform:”

“A growing chorus of small lenders, affordable housing advocates, civil rights groups and capital market participants have asked that the GSEs’ regulator and conservator exercise the authorities provided him under HERA, and permit the GSEs to build adequate levels of capital so that they do not pose a risk to the public. 

These same groups have also asked that once the conservator is satisfied the GSEs are adequately capitalized, the GSEs regulator then begin the process of releasing the GSEs – as required by HERA — from direct government control.”

Lastly, David Fiderer, “How the $187 Billion GSE ‘Bailout’ Went Awry:”

“None of it seems to make any sense. Under federal statute, the FHFA, as conservator, must, “take such action as may be necessary to put the regulated entity in a sound and solvent condition.” No one has ever given a cogent explanation as to how the original cash drawdowns, and the subsequent cash distributions, including a 100% dividend sweep, serves that goal.”

Again, if your goal is to understand all of the issues related to Fanniegate, you should read as much as possible. Fortunately, there is recent, increased interest and debate over Fannie and Freddie, predominately since the presidential election. Read much and form your own, independent opinion!

Keefe Bruyette & Woods

Which Keefe Bruyette & Woods (KBW) analysis are you going to believe?

Months before the Government seized Fannie Mae and Freddie Mac, KBW upgraded their analysis to “Outperform” with a price target of $48 for Fan and $46 for Fred.  KBW did not just keep their analysis to “Market Perform” they upgraded their analysis — right before the Government placed the companies into conservatorship.

Seems like they were off on their analysis in 2008!

KBW has had mixed analysis since the conservatorship.

In October 2009 KBW stated the shares of Fannie and Freddie was worthless. At the time, Bose George, KBW real estate analyst, said “in this scenario, both the common and preferred equity of the GSEs should be worthless.”

Seems like KBW was off on this analysis in 2009, too. The preferred and common shares are currently trading far from a $0 valuation.

On Friday, Mr. George said:

“Shares of Fannie Mae (FNMA) and Freddie Mac (FMCC) have rallied sharply over the past two days following comments from Steven Mnuchin, the incoming Treasury Secretary, stating that the new administration wants to get the GSEs out of government hands. He also noted that resolving the GSE issue was a top 10 priority for the new administration. While it remains unclear how any privatization would work, we believe that even in the best case scenario, where the shares are privatized with a 2.5% capital requirement, the capital need will meaningfully dilute the value of the common shares, suggesting little upside from current levels. We continue to believe that the most likely scenario is one in which the common shares have no value. We reiterate our Underperform ratings and $1 price targets for both companies.”

Apparently now the preferred shares are a safe bet according to KBW, while the common shares are worth $1. If you are going to trade on this analysis you need to convince yourself that KBW is right this time. If you followed their advice in the past you likely would have lost a lot of money. Good luck to you this time if you believe them now.

Here’s what KBW said in 2014:

“Inertia is a powerful ally of Fannie Mae and Freddie Mac. The longer Congress avoids acting on mortgage-finance legislation, the greater the chances the two companies survive.”

Reminds me of the old saying, “even a broken clock is right twice a day.”

KBW’s thesis for the common stock only being worth $1.00 is centered around the companies’ lack of capital. The terms of the conservatorship reduces the companies’ capital to $0 by the end of next year. These terms were established and followed by the Federal Housing Finance Agency (FHFA) whose mission was supposed to be to preserve and conserve the assets of Fan/Fred as their conservator.

Steven Mnuchin has made it clear that he wants to move quickly in removing Fannie and Freddie from conservatorship stating:

“It makes no sense that these are owned by the government and have been controlled by the government for as long as they have. In many cases this displaces private lending in the mortgage markets and we need these entities that will be safe. So let me just be clear— we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again. But we gotta get them out of government control.We’ll get it done reasonably fast.”

The new Administration believes that the conservatorship is a farce and plans to resolve the issues as quickly as possible. The quickest way to solve the issue is to unwind the conservatorship and return the capital that the current Administration robbed from the companies.

End the conservatorship, end the net worth sweep, cancel the senior preferred stock, cancel the warrants and return Fannie and Freddie’s capital…

If these things happen then the common stock is worth more than the $1.00 target placed by KBW. I’ve seen people speculate that the stock could be worth $100 – 150 if the senior preferred and warrants are cancelled. I’ve seen other projections that the common stock is worth $10 – 30 even if the warrants are exercised.

Anyone interested in investing in the common stock of Fannie and Freddie should certainly conduct thorough due diligence and arrive at their own conclusion. Your research will likely discover there are just as many folks claiming doom and gloom for the common stocks as there are people claiming an astronomical return potential.

Just realize that KBW is just one analyst — one whose analysis has been all over the board.

 

Disclaimer: I own common and preferred shares in both Fannie Mae and Freddie Mac.

Non-Severability

The following section is a part of the SENIOR PREFERRED STOCK PURCHASE AGREEMENT (SPSPA) between the US Treasury and Fannie Mae/Freddie Mac.

The clause states that if any part of the agreement is determined to be illegal or unenforceable, then the whole agreement should be rescinded. In other words, if the Third Amendment (which is obviously a integral part of the whole) is determined to be illegal, then the Warrants are also illegal.

6.12. Non-Severability. Each of the provisions of this Agreement is integrated with and integral to the whole and shall not be severable from the remainder of the Agreement. In the event that any provision of this Agreement, the Senior Preferred Stock or the Warrant is determined to be illegal or unenforceable, then Purchaser may, in its sole discretion, by written notice to Conservator and Seller, declare this Agreement null and void, whereupon all transfers hereunder (including the issuance of the Senior Preferred Stock and the Warrant and any funding of the Commitment) shall be rescinded and unwound and all obligations of the parties (other than to effectuate such rescission and unwind) shall immediately and automatically terminate.

The following section is also contained in the SPSPA:

6.7. Effect of Order; Injunction; Decree. If any order, injunction or decree is issued by any court of competent jurisdiction that vacates, modifies, amends, conditions, enjoins, stays or otherwise affects the appointment of Conservator as conservator of Seller or otherwise curtails Conservator’s powers as such conservator (except in each case any order converting the conservatorship to a receivership under Section 1367(a) of the FHE Act), Purchaser may by written notice to Conservator and Seller declare this Agreement null and void, whereupon all transfers hereunder (including the issuance of the Senior Preferred Stock and the Warrant and any funding of the Commitment) shall be rescinded and unwound and all obligations of the parties (other than to effectuate such rescission and unwind) shall immediately and automatically terminate.

If a court rules that the Third Amendment is illegal, it will effectively be submitting an order that “curtails the Conservator’s powers.” This court order could lead to “declaring the entire Agreement null and void.”

Another section in the SPSPA describes its foundational authority:

4.3. Authorization and Enforceability. All corporate or other action on the part of Seller or Conservator necessary for the authorization, execution, delivery and performance of this Agreement by Seller and for the authorization, issuance and delivery of the Senior Preferred Stock and the Warrant being purchased under this Agreement, has been taken…The Agency is acting as conservator for Seller under Section 1367 of the FHE Act. The Board of Directors of Seller, by valid action at a duly called meeting of the Board of Directors on September 6, 2008, consented to the appointment of the Agency as conservator for purposes of Section 1367(a)(3)(I) of the FHE Act, and the Director of the Agency has appointed the Agency as Conservator for Seller pursuant to Section 1367(a)(1) of the FHE Act, and each such action has not been rescinded, revoked or modified in any respect.

I proved in an earlier post that Hank Paulson’s version of events on September 5 and 6, 2008 as described in his book On the Brink contradicts the official record of events as chronicled by the official Treasury calendar record. If anyone is ever allowed to review the corporate records of Fannie and Freddie it will either substantiate or refute my claim that the boards of both companies did not hold an official board of directors meeting. If there was no meeting, there was no board consent thus invalidating the entire conservatorship.

Also, if the Third Amendment is found to be illegal, there is a provision in the stock certificate that would reclassify the money returned to the Treasury as repayment of the money the Government injected into the companies:

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 legalJy available… 

Further, the Government’s action with Fannie/Freddie has been compared to its action with AIG. In 2008, the Treasury and Federal Reserve committed $182B to bailout AIG. In return, the Government received $205B from AIG — netting the Government $23B. The Government received and exercised 79.9% warrants in AIG, similar to Fan/Fred. The point is that the warrants were used to pay down the money AIG borrowed from the Government.

Details of the payback can be found here and here.

According the the ProPublica Bailout Tracker, Fannie and Freddie received $182B (similar to AIG) and have returned $250B netting the Government $68B — approximately three times the amount returned by AIG.

It is clear the purpose of the warrants in both cases (both equalling $182B) was to recapture the money injected into the companies. Therefore, there is no need for the Government to exercise the Fan/Fred warrants.

The Financial Times had a recent article that stated if the Government exercised the Fan/Fred warrants it could realize up to $200B from the sale. Think about that for a moment… The Government injected $182B into Fan/Fred; received $250B (to date) in return and would make an additional $200B if they exercised the warrants — a combined return of $450B…!

It is simply ludicrous to suggest the Government is owed $450B on a $182B injection (which many believe was unnecessary in the first place).

If the Government thought they needed to exercise the Fan/Fred warrants to recoup their investment, they would have already done so. With AIG, the bailout occurred in 2008 and the Treasury concluded all of their warrant transactions by 2013.

In summary, the Government acted outside its legal authority when enacting the conservatorship and the original SPSPA. It then acted greedy and reckless when it enacted the Third Amendment. Therefore, the Government should pay the consequence by having the entire senior preferred stock purchase agreement rescinded and unwound as clearly stated in their own Non-Severability clause in the SPSPA.

Repayment and Warrants

There has been much debate on whether Fannie and Freddie ever had the ability to repay the money that the Treasury forced upon them. Many in the government — and even in the media — claim that Fannie and Freddie lack the option to repay the money received from Fan/Fred by Treasury by stating that it is merely a return on investment.

However, reviewing this attached Treasury report published in 2012 it clearly states that Treasury believed then that Fan/Fred had not only the ability to repay, but also states repayment was likely.

Further, Treasury makes it clear that the warrants were merely a vehicle to recoup the investment into the entities. So, if all the money is returned to the Treasury, the warrants are pointless. This Treasury document claims nothing about “punitive terms” or “risk/reward return.” No, it clearly describes the purpose of the warrants — to recoup the original investment.

The following passage appears on page 8 of the Treasury report:

“Probability of the Enterprises and the FHLBs fulfilling the terms of their obligations – The structure of the PSPAs, with their liquidation preference over all other equity, including preferred equity, combined with the PSPAs’ restrictions on debt issuance, enhance the probability of both Fannie Mae and Freddie Mac ultimately repaying amounts owed.

Need to maintain the Enterprises’ and the FHLBs’ status as private shareholder-owned companies – Fannie Mae and Freddie Mac may emerge from conservatorship to resume independent operations, or they may emerge in some other form reflecting legislative changes to their congressional charters. Conservatorship preserves the status and claims of the preferred and common shareholders. The value of the warrants issued to the government under the terms of the PSPAs could potentially increase, thereby providing enhanced value to the taxpayers. Upon the government’s exercise of the warrants, the GSEs would be required under the terms of the PSPAs to apply the net cash proceeds to pay-down the liquidation preference of the senior preferred stock.”

 

The Treasury report can be found here: https://www.treasury.gov/about/budget-performance/Documents/CJ_FY2012_GSE_508.pdf

Give Me Love (Give Me Peace On Earth)

Give me love
Give me love
Give me peace on earth
Give me light
Give me life
Keep me free from birth
Give me hope
Help me cope, with this heavy load
Trying to, touch and reach you with,
heart and soul

OM M M M M M M M M M M M M M
M M M My Lord . . .

PLEASE take hold of my hand, that
I might understand you

Won’t you please
Oh won’t you

Give me love
Give me love
Give me peace on earth
Give me light
Give me life
Keep me free from birth
Give me hope
Help me cope, with this heavy load
Trying to, touch and reach you with,
heart and soul

OM M M M M M M M M M M M M M
M M M My Lord . . .

PLEASE take hold of my hand, that
I might understand you

A reflection on too big to fail

September 28, 2016

By Sally Greenberg

Nearly eight years after the Great Recession, where unscrupulous lending practices brought our global economy to a breaking point, we’ve learned that the Big Banks have learned little since the meltdown and returned to business as usual.

The latest culprit is Wells Fargo, where an investigation by the Consumer Financial Protection Bureau uncovered a fraudulent debit and credit card scam affecting millions of unwitting Wells Fargo customers. The executive who oversaw this rapacious operation, Carrie Tolstedt, announced over the summer she is retiring with a reported package of $124 million, and Wells Fargo has failed to hold anyone at the top responsible, while firing more than 5,000 of the workers who were forced to participate in this illegal activity.

And yet, this incident is not the first time we’ve seen the largest financial institutions game the system since the Great Recession. In recent years, Wells Fargo and other large banks have been fined and faced lawsuits and investigations regarding financial violations and misuse of ordinary Americans’ money.
How can this still be happening? In the eight years since the financial crisis, dozens of Congressional hearings, thousands of news stories, a host of best-selling books, and a blue ribbon commission promised to help us understand what went wrong and how to prevent a recurrence. The Dodd-Frank Act became law amidst much fanfare – and opposition. But since then, the nation’s biggest banks including Wells Fargo, have only gotten bigger, and as this newest episode demonstrates, old habits die hard.

Today, almost eight years later, the six largest U.S. financial institutions now have assets of some $10 trillion – that’s more than half of our nation’s GDP. Yet, against this backdrop of stratospheric growth, Wells Fargo has shown that nothing has changed and their leadership continues to look for ways to maneuver around the rules to drive profit. Importantly, these large financial institutions, now, would like to take over the secondary housing market. Already the largest mortgage lending bank in the nation, Wells Fargo has spent more than $20 million in the last few years lobbying Congress to replace mortgage backers Fannie Mae and Freddie Mac with – you guessed it – a more bank-centric model. Ironically, it was Wells Fargo that settled with the Department of Justice for $335 million over charges that it sold fraudulent loans to Fannie and Freddie.

Here are the facts: in the years since the global financial crisis, significant reforms to Fannie and Freddie have allowed them to become profitable again and repay $187 billion to the Treasury Department, plus another $60 billion in dividend payments. Still, some say that Fannie and Freddie not only caused the crisis, but are emblematic of big government cronyism and demand they be dismantled. Others say the two government-sponsored enterprises have helped tens of millions of Americans achieve the American Dream of homeownership and create wealth for future generations. So far, no one has come up with an acceptable alternative for keeping the nation’s mortgage market liquid and stable enough so qualified, creditworthy buyers can obtain sustainable long-term home loans.

The most common-sense solution is to continue reforming Fannie and Freddie, allow them to retain earnings and rebuild their capital base, and protect taxpayers against future bailouts. The most reckless decision would be to hand over their business to Wells Fargo or some of its big-bank peers and let them gamble away our future. Hopefully, policymakers have learned from the age-old idiom, “fool me once, shame on you; fool me twice, shame on me” – with the latter only hurting working Americans’ ability to achieve long-term economic security.

Sally Greenberg is executive director of National Consumers League.

http://webcache.googleusercontent.com/search?q=cache:http://origin-nyi.thehill.com/blogs/congress-blog/economy-budget/298370-a-reflection-on-too-big-to-fail

 

Fannie and Freddie Will Be Profitable After Their Next Bailouts, Too

AUG 8, 2016

 

The Federal Housing Finance Agency released the results of the annual stress tests for Fannie Mae and Freddie Mac on Monday, and the report is a nice little milestone. For the first time, the crisis-era government bailouts of the government-sponsored entities,combined with their hypothetical future bailouts, are profitable for the government. Here’s the accounting:

The government put $187.5 billion into Fannie and Freddie. It has gotten back $246.7 billion, so it’s up $59.2 billion. In the “severely adverse scenario” of the Dodd-Frank stress tests, it will have to put in another $49.2 billion. That will still leave it with a cool $10 billion in profit.

Now I am cheating here a bit. Strictly speaking, the stress tests found that “Fannie Mae and Freddie Mac could need as much as $125.8 billion in bailout money from taxpayers in a severe economic downturn.” That number is bigger than my $49.2 billion. The difference is a $76.7 billion “impact of re-establishing valuation allowance on deferred tax assets.” Basically, Fannie and Freddie lost a lot of money in the past, which reduces their income taxes in the future, unless they don’t have income in the future, in which case it doesn’t. And they count the future tax reductions as an (enormous) asset on their balance sheets, unless they don’t expect to have income in the future, in which case the asset goes away, reducing their equity and requiring — perhaps — another bailout. The FHFA ran the stress tests two ways, both assuming that the deferred tax asset went away and required more bailout funds, and not. The Fannie/Freddie deferred tax assets got quite a workout in the last bailout, and I can only assume that any future bailout would involve lots of contortions around them, but really who cares. The disappearance and reappearance of the deferred tax assets are not a real cash expense, and if everyone just agreed to ignore them, nothing in the world would be any different. So let’s just ignore them.

The FHFA might be cheating here a bit, too, in the boring sense that any time a government agency releases stress test results, you can complain that the test wasn’t stressful enough. The 2016 stress test scenario “is based upon a severe global recession which is accompanied by a period of elevated corporate financial stress and negative yields on short-term U.S. Treasury securities,” which sounds bad-ish, but which seems to leave Fannie and Freddie curiously untouched. The scenario results in credit losses equal to 0.56 percent of their combined portfolio, meaning that for every $100 of loans that they own, Fannie and Freddie would get back $99.44 even in a “severely adverse” stress scenario. That seems … maybe … a little generous? For “severely adverse”?

But I don’t make the stress test rules, and this stress test says another crisis would cost taxpayers just $49.2 billion in new Fannie and Freddie bailout money, less than the taxpayers have made in profits on the last bailout. And then, of course, after the new bailout, taxpayers would presumably go back to raking in money from Fannie and Freddie, and end up even further ahead. Until the next bailout, world without end.

There is a weird … idea? meme? accounting error? … that says all of this is somehow a risk to the taxpayers that can be solved by giving Fannie and Freddie more money now. The way Fannie and Freddie work now is that, in round numbers, they operate with zero capital: Any profits that they make each quarter go to the Treasury, and if they have a loss in a quarter, the Treasury makes up the difference. In recent years they’ve had profits and returned money to Treasury. (Thus the $59.2 billion of government profits.) But it’s always possible that in the future they will lose some money, and Treasury will have to come up with the extra money. For instance, if the stress test scenario occurred, Treasury would have to come up with an extra $49.2 billion. It would still be ahead, but less ahead.

That’s true: The government, in every practical sense, “owns” Fannie and Freddie, so it’s at risk if they lose money. The weird part is the idea that the government can avoid this risk by just letting Fannie and Freddie keep all the money that they make. This is called “building capital,” and the idea is basically that if, instead of paying that $59.2 billion to the Treasury, Fannie and Freddie had kept it, there would be much less risk that Treasury would have to come up with $49.2 billion to bail them out in the future.

Which, again, is true. It’s just that then Treasury wouldn’t have the $59.2 billion. Getting $59.2 billion and giving back $49.2 billion of it still leaves you with $10 billion. Just never getting the $59.2 billion in the first place is strictly worse.

But it is easy for me to say that, because I think of Fannie Mae and Freddie Mac as wholly owned subsidiaries of the U.S. Treasury. This makes the analysis easier. For instance, the stress tests aren’t about whether Fannie and Freddie “could need as much as $125.8 billion in bailout money from taxpayers,” or whatever; they’re just about how much that division of the government could lose in a recession. (In the same way that, when the U.S. Postal Service loses money, no one calls it a “bailout.” It’s just a loss.) It’s of no interest whether the division has a lot of capital, or a little capital, or no capital, or negative capital: The U.S. government has plenty of money, and that’s the relevant unit of account.

Not everyone agrees. I mean, Fannie and Freddie aren’t wholly owned subsidiaries of the government: They have common and preferred stock outstanding, and while the current terms of the bailouts prevent them from ever making payments on that stock, the shareholders have been suing for ages to try to reverse those terms and get their money back. They argue, with some justification, that the bailout terms are unfair and illegal, and that they should get back their rights as owners.

The government is fighting those lawsuits, but it too can’t quite bring itself to say that Fannie and Freddie are fully controlled agencies of the government. Partly this is an accounting issue — by not consolidating Fannie and Freddie, the government doesn’t have to count their debt toward the debt ceiling — but it is also sort of a political-philosophical issue. Nobody ever exactly made the choice to permanently nationalize the entire U.S. mortgage market. Fannie and Freddie are in “conservatorship,” a supposedly temporary state of government protection that happens to have lasted for the better part of a decade. There’s no mandate or plan to keep them nationalized forever, and everyone has to talk piously about the importance of returning private capital to the mortgage markets.

Everyone kind of knows the basic mechanics of how to do that: Create some privately owned mortgage companies, either from scratch or from the bones of Fannie and Freddie, to buy or guarantee mortgages. Raise capital for those companies from investors, perhaps giving existing Fannie/Freddie investors some credit for their existing holdings, perhaps not. Regulate those companies, and make sure they’re well enough capitalized to absorb any reasonable credit risk in the mortgage market. Let those companies buy some sort of backstop from the government, at a fair price, to further socialize the credit risk of mortgages.

And yet people have been talking about this for ages, and nothing much has happened. One reason for this is pretty obvious: For the government, keeping Fannie and Freddie as a branch of the government is pretty great. They’re easy to control, available as an instrument of housing policy, and, crucially, profitable. Perhaps things will change if Fannie and Freddie run into trouble again. But the latest stress tests suggest that even that may not change anything.

  1. The initial bailout and repayment figures come from ProPublica’s great bailout trackers for Fannie Mae and Freddie Mac. The stress test numbers come from the “Treasury draws required” lines in the “Results without re-establishing valuation allowance on deferred tax assets” column in the FHFA report, pages 6 and 7.Incidentally, the last time we talked about the Fannie/Freddie stress tests, two years ago, things looked much worse, with an $84.4 billion draw required even without accounting for deferred tax assets.
  2. It seems especially silly to get worked up about Fannie and Freddie’s potential tax liabilities when they are just divisions of the U.S. government anyway, but that’s the sort of thing that you’re not supposed to say, so I’m putting it in a footnote.
  3. It’s not really zero, though it will be by 2018. From the Fannie Mae 10-Q:

    In addition, as a result of our agreements with Treasury and dividend directives from our conservator, we are not permitted to retain our net worth (other than a limited amount that will decrease to zero by 2018), rebuild our capital position or pay dividends or other distributions to stockholders other than Treasury.

    Right now the “capital reserve amount” is $1.2 billion for each entity (see page 5 of the Fannie 10-Q and page 18 of the Freddie one), which is close enough to zero for our purposes.

  4. Of course even if Treasury had to come up with more — say, the $125.8 billion number that the stress tests also mention — getting the $59.2 billion first is still a good thing. Let’s say the government had left that $59.2 billion in the entities, and then they found themselves $125.8 billion short. The $59.2 billion would be wiped out, and the entities would still be $66.6 billion short, even after building all that capital. Then what? Well, maybe the government would just allow them to fail, and private creditors — holders of Fannie Mae and Freddie Mac securities — would eat the loss. But … um … probably not? One, because the government has funding commitments to provide up to $258.1 billion more in funding to the entities (see page 3 of the stress test results), but two, because those funding commitments are in place for a reason. Fannie and Freddie are not just random private companies that the government can cheerfully allow to fail if they eat through their capital: They are the underpinnings of the mortgage system. So Treasury rescued them in their last crisis, and without some sort of structural reform, it will rescue them in their next crisis.
  5. Ugh, I’m sure someone does, but please don’t tell me about it.
  6. So for instance:

    FHFA Director Melvin Watt in a February speech warned that the companies’ falling capital buffers could one day cause investors to doubt their guarantees of mortgage-backed securities. Such uncertainty would cause mortgage rates to go up.

    “The most serious risk and the one that has the most potential for escalating in the future is the enterprises’ lack of capital,” Watt said.

    This makes no sense if you think that investors think that the companies are government agencies, and that the government is on the hook for their guarantees. I think that, because (1) the government was effectively on the hook for their guarantees in 2008, and (2) since then the relationship between the government and the entities has gotten even closer. But the government can’t … just … say that. So the government has to pretend that it doesn’t back Fannie and Freddie, and that investors don’t think it backs Fannie and Freddie.

  7. And even do something about it, like the credit risk sharing deals that allow Fannieand Freddie to offload a portion of their credit risk to the private market — while still keeping the entities themselves in conservatorship.
  8. This paragraph, in broad outline, describes the Johnson-Crapo plan (which zeros the existing preferred shareholders), the Fairholme Capital Management plan (which gives those existing holders equity in the new entities), and even the Parrott-Ranieri-Sperling-Zandi-Zigas plan, which is a little different (involving fixed-dividend securities in a new national corporation) but has similar basic features.
  9. I wrote this two and a half years ago:

    My assumption has long been that the status quo is great for the government. Right now, Fannie and Freddie are completely controlled by the federal government, while keeping the technical trappings of private ownership (20.1 percent private shareholders, no explicit government guarantee) and thus staying off the Treasury’s balance sheet. They can be used as a tool of housing policy (particularly, they can keep guaranteeing cheap mortgages) without being explicitly federalized.

    Still true! Still the same status quo.