The Elephant in the Room

Activist investors have complicated the discussions over what to do with Fannie Mae and Freddie Mac. Powerful fund managers argue the two should be allowed to recapitalize and continue in their role as private companies. One might say they are the elephant in the room when it comes to housing finance reform options.

Mortgage Banking

August 2014

By Robert Stowe England


Since Fannie Mae and Freddie Mac returned to profitability in the first quarter of 2012, there has been a steady march of deep value investors taking long positions in the shares of the mortgage giants. On the face of it, this is a very risky trade, given the political realities in Washington.


The Obama administration, for example, has since 2011 called for the two government-sponsored enterprises (GSEs) to be wound down and liquidated, a view broadly shared across the political spectrum in Washington. On political risk alone, then, the shares should be worth close to nothing.


Yet, rising price levels for shares in the over-the-counter market for the mortgage giants suggest that investors find the odds that shares could return to levels before the financial crisis, while still remote, still intact.


Junior preferred and common equity shares, which had been trading for pennies in the aftermath of the government takeover of the mortgage giants in September 2008, began to rebound in March 2013 and have followed a bumpy path higher since then.


Fannie Mae common shares, for example, only 29 cents on March 12, 2013, rose to $5.44 on May 29, 2013, before falling back over last summer. This year the shares have been on the march again, rising from $2.98 at the beginning of the year to a high of $6.35 on March 11, then falling back to $3.92 in late June.


Fannie Mae’s S series--the largest of the junior preferred issues--rose from $1.90 on March 12, 2013, to a high of $6.85 on May 29, 2013, and then fell back. Since then, shares fell as low as $4.10 and rose as high as $12.75 earlier this year, falling back to around $10.44 a share in late June. The coupons on these preferred equity shares range from 7.75 percent to 8.37 percent--a huge return in today’s market.


Through the political lens


For close observers of the political landscape in Washington, the equation looks different than it does for deep value investors, who see the risks as low and the rewards potentially high.


“For investors who got into the shares when they were trading at 2 or 3 cents on the dollar, it is not an unreasonable bet that Fannie and Freddie have a 2 [percent] or 3 percent chance of coming back,” says Mark Calabria, director of financial regulation studies at the Cato Institute, Washington, D.C.


However, current prices for preferred and common shares “are just unrealistic in terms of the probabilities of success,” says Calabria.


“They’re just betting on good luck to some extent--which is not necessarily a bad bet, knowing Washington.”


An investment in preferred or common shares at current prices can only pay off if Fannie Mae and Freddie Mac are reprivatized--an outcome Calabria considers quite remote.


“A lot of the guys who are doing this have historically been distressed-debt buyers,” says Calabria. “I think what they miss is that for a lot of distressed companies, you can look at the fundamentals and feel that they’re overvalued. But most companies just don’t have the kind of political uncertainty and risk that Fannie and Freddie have, which is another dimension,” he adds.


These investors can be compared, he says, “to the firms that bought Argentinian debt for pennies on the dollar--which was more of a political gamble than anything else,” Calabria says. Argentina defaulted on $95 billion in debt in 2001 and in May this year agreed to repay $9.7 billion of its arrears over a 10-year period.


The investors, of course, tell a different story about the prospects for Fannie Mae and Freddie Mac, and they have a different vision of mortgage reform.


What GSE investors think


Bruce Berkowitz, the founder, chief executive officer and chief investment officer of Fairholme Capital Management LLC, Miami, the lead player among the roster of prominent investors in the GSE trade, warns Washington not to throw the baby out with the bathwater when it reforms mortgage finance.


“Without Fannie and Freddie, there would be no middle-class housing and no 30-year mortgage. They are not just part of our housing finance system. They are the system,” he told Institutional Investor. Berkowitz wants to see Fannie and Freddie reformed--not liquidated--because he thinks they are better than any of the alternatives being discussed in Washington.


In May, a confident Bill Ackman, founder and chief executive officer of Pershing Square Capital Management LP, New York, predicted Fannie Mae common shares could rise to as much as $47 in a presentation at the Sohn Investment Conference  in New York titled “It’s Time to Get Off Our Fannie.”


“The best way to maintain widespread availability and affordability of the 30-year, fixed-rate, pre-payable mortgage and provide a substantial profit to the taxpayer is to reform the GSEs,” Ackman told Sohn conference attendees.


Ackman laid out a plan to reform and privatize the GSEs. For starters, the two firms would have to significantly increase the capital they must hold to back up their guarantee business to 2.5 percent, instead of the historic minimum of 0.45 percent.


“A 2.5 percent equity ratio would amount to more than four times the cumulative losses in the GSEs’ guarantee business during the financial crisis,” he said. That should assure investors of the safety and soundness of the reformed GSEs.


Ackman would also limit the size of the GSEs’ retained portfolio of mortgage assets to only $100 billion, down from the $250 billion allowed while they are in conservatorship.


Last fall, Pershing Square revealed it had taken positions equal to about 10 percent of all outstanding common shares in both Fannie Mae and Freddie Mac. During the first quarter of 2014, Pershing raised its stake to 11 percent in each GSE. By early June, this represented a stake of $2.9 billion in Fannie Mae and $1.6 billion in Freddie Mac.


Junior preferred equity


Before Ackman’s multibillion-dollar stake in common shares, it was the junior preferreds that were the main focus of investors in Fannie Mae and Freddie Mac. For example, Bruce Berkowitz, president of Fairholme Fund, Miami, a pioneer activist investor, purchased $500 million in junior preferreds of both Fannie and Fannie.


Berkowitz also bought 26 million common shares of Fannie Mae and 19.4 million of Freddie Mac. The Fairholme Capital Fund, NASDAQ ticker symbol FAIRX, is a mutual fund.


Chicago-based Morningstar rated Berkowitz the manager of the decade in 2010 and currently rates the Fairholme Capital Fund silver--its second-highest rating.


On March 11, 2014, Berkowitz sold a small piece of his GSE holdings--6.8 million common shares of Fannie Mae and 5.7 million common shares of Freddie Mac--for a total of $50 million. This small stake was sold to Carl Icahn, founder and majority shareholder of the $32.9 billion New York-based Icahn Capital LP, a man whose worth Forbes estimates to be $24.5 billion.


By the end of the first quarter, Berkowitz had more than doubled on paper the value of his $500 million investment in GSE junior preferreds. In a filing with the Securities and Exchange Commission (SEC), Fairholme Capital reported that its holdings of Fannie and Freddie junior preferreds were valued at $1.395 billion or 16 percent of the fund’s $8.65 billion in assets under management.


Richard Perry is another activist investor who jumped into GSE preferreds. His investment came through Claren Road Asset Management, New York, which is owned by The Carlyle Group, L.P., based in Washington, D.C., and Perry Capital LLC, New York.


In addition, John Paulson, president and portfolio manager of Paulson & Co. Inc., based in New York, is an investor in the GSE shares. Paulson has lobbied senior staff of the Senate Banking Committee to abandon its plan to liquidate Fannie and Freddie, according to Bloomberg News. So far the effort has not met with any success, as no such provision has made it into any of the proposed mortgage finance reform bills that have been introduced so far in Congress.


Investors see role for GSEs


While all the prominent investors in the GSEs’ stock are steadfastly supporting the recapitalization of the GSEs, some among them are open to a wide range of outcomes, including eventually winding them down and liquidating them--but only after recapitalizing them first.


“What we want to see is a system that encourages private capital to come back into the market. In our view, the way to do that is to circle back to the beginning, first allowing the GSEs to recapitalize,” says Michael Bopp, partner in the Washington, D.C., law firm of Gibson, Dunn & Crutcher LLP. Bopp is one of the Gibson Dunn attorneys, led by partners Theodore Olson and Matthew McGill, who are representing Perry Capital in a lawsuit against the Treasury’s August 2012 decision to sweep all the earnings from Fannie and Freddie into the coffers of the Treasury Department.


“Right now there is no capital cushion at the GSEs to withstand any kind of a negative event in the markets,” says Bopp. “So, what happens with the legislation we’ve seen in both the House and the Senate? You liquidate the GSEs and hopefully private capital will step in and take over.”


Bopp contends that leaves a gap between the time when the GSEs are liquidated and the time when private capital might conceivably enter the market and take the place of the GSEs. Recapitalizing and privatizing the GSEs would allow for a transition to the reformed housing finance market, he maintains.


“When you look at the private securitization markets, they haven’t rebounded. They don’t exist,” says Bopp. “And so, going from where we are now to eliminating the GSEs to relying on Perry Capital and other private providers of capital in the housing markets, it’s not going to work,” Bopp argues. “We don’t see how capital is going to be incentivized to come back in to the markets--at least not as quickly and not to the degree needed to fill the hole if the GSEs are liquidated.”


Treasury’s senior preferred shares


The biggest obstacle facing the owners of the junior preferred shares is the standing and terms of the senior preferreds, all of which are held by the U.S. Treasury in return for cash injections made into the GSEs when both companies were losing money.


During the years Fannie Mae and Freddie Mac were unprofitable--from the fourth quarter of 2008 to the fourth quarter of 2011--Treasury would issue cash infusions under the broad agreement to provide each of the GSEs up to $100 billion each. A second agreement provided another $100 billion each.


In the first quarter of 2012, Fannie Mae received its last drawdown of $4.51 billion, raising its total cash infusion from the government to $116.15 billion, according to the Federal Housing Finance Agency (FHFA).


Then in the second quarter of 2012, Freddie Mac had its last drawdown of $19 million, bringing its cumulate enterprise draws to $71.34 billion. Combined, the two GSEs required $187.49 billion in cash infusions from September 2008 through June 2012.


Meanwhile, the two GSEs have paid $213.04 billion in dividends to Treasury as of May 2014, according to a report issued by the FHFA.


Over the next 10 years, the GSEs will return an estimated $179.2 billion in profits to the taxpayers if they continue under federal conservatorship, according to a March 2014 analysis published in the White House Office of Budget and Management’s annual budget proposal for 2015. If nothing changes from the status quo, then, in 10 years that would bring the total paid by the GSEs to the U.S. government to $392 billion.


Perhaps the most persuasive argument that GSE investors are making is that the Treasury violated shareholders rights when in August 2012 it altered its original agreement to receive a 10 percent dividend from its investment in Fannie Mae and Freddie Mac—and to instead take virtually all profits generated by the GSEs and pass those funds on to the U.S. Treasury. Since the two GSEs have become profitable, those profits have acted to reduce the budget deficit.


The sweeps amendment


In what is known as the August 2012 third amendment to the original 2008 senior preferred stock purchase agreement, FHFA and Treasury agreed that Fannie Mae and Freddie Mac would pay out as dividends nearly all their actual earnings in any given quarter. This earnings sweep essentially prevents the two mortgage companies from recapitalizing, a step that could prepare them to be reprivatized.


The sweeps amendment, as it is also known, prevented the GSEs from disposing of any or all of their assets without permission from the FHFA and Treasury. The amendment requires Fannie Mae and Freddie Mac to continue to reduce their portfolio of mortgage assets by 15 percent a year, from $650 billion in 2012 until each portfolio is reduced to $250 billion.


The sweeps amendment essentially makes it nearly impossible for the holders of junior preferred shares to have the dividend payments restored and from benefiting from the sale of assets at the expected time the GSEs would be liquidated and sell their assets. The proceeds from those sales would go to the U.S. Treasury, unless there were some other arrangement made at the discretion of FHFA and Treasury.


Some of the investors in junior preferreds--such as Fairholme Capital’s Berkowitz--say they decided to invest ahead of the August 2012 sweeps amendment when expectations were rising that the GSEs would return to profits. A profitable Fannie Mae and Freddie Mac would then be able to restore dividends to the junior preferred equity shareholders at some point, both driving up the value of the shares and providing a high coupon yield.


The investors point out that Treasury’s decision to essentially strip the equity shareholders of Fannie Mae and Freddie Mac of any potential to recover the value of the shares stands in contrast to the federal government’s treatment of AIG, for example, and even banks like Citigroup and Bank of America and automakers General Motors and Chrysler, where the federal government injected billions in capital from the taxpayers.


There was not even the possibility that after paying back the taxpayers, the funds advanced to save the GSEs, plus the dividends, that the two would be allowed to survive. The decision made by Treasury was based on the widely held view that the way that Fannie Mae and Freddie Mac were set up--a hybrid corporation with a public mission but private ownership--was a flawed model that led to their demise and should not be resurrected.


Investor lawsuits


The Treasury Department’s sweeps amendment in August 2012 that amended the terms affecting the preferred equity shares of the GSEs is the basis for a number of shareholder lawsuits brought against FHFA, Treasury and broadly against the U.S. government.


Both Perry Capital and the Fairholme Fund filed lawsuits in early July 2013, a month after Senators Bob Corker (R-Tennessee) and Mark Warner (D-Virginia) introduced mortgage reform legislation. The Corker-Warner bill called for winding down Fannie and Freddie and replacing them with a new mortgage finance system and a new national guarantor, the Federal Mortgage Insurance Corporation. In March 2014, another major piece of GSE reform legislation was introduced by Senate Banking Committee Chairman Tim Johnson (D-S.D.) and ranking member Mike Crapo (R-Idaho), that would also wind down the two GSEs and also created a new regulator, the FMIC, that would supervise private-sector firms that would package mortgages into a pool and sell mortgage securities backed by a Mortgage Insurance Fund. The Senate Banking Committee passed the bill in May 2014 on a 13 to 9 vote.


In July 2013 the House Financial Services approved a mortgage reform bill put forth by its Chairman Jeb Hensarling (R-Texas). The Hensarling bill would phase out Fannie and Freddie over a five-year period and replace them with the National Mortgage Market Utility that would securitize mortgages without a U.S. government guarantee for mortgage-backed securities, although it would allow the Federal Housing Administration play an expanded guarantee role in an economic crisis.


In the case Fairholme Funds Inc. v. U.S., filed in the U.S. Court of Federal Claims in Washington, D.C., the plaintiff is seeking compensation for the decline in the value of its junior preferred shares after Treasury adopted the sweeps amendment. The Fairholme Fund argues that the sweeps amendment violates the takings clause of the Fifth Amendment of the U.S. Constitution, which provides that private property shall not be taken without just compensation.


“The holders of Fannie and Freddie securities had a property right to receive dividends in certain instances and a claim upon the liquidation preference if the entities were ever sold and wound down or terminated in some way, and both of those rights have been reduced to zero,” says David Thompson, managing partner at Cooper & Kirk PLLC, Washington, D.C., which represents the Fairholme Fund.


Treasury and FHFA have responded by saying that the securities are not worthless and clearly have trading value. Fairholme argues that the only reason they have any trading value at all is due to the lawsuits filed by Fairholme and others.


In February 2014, Judge Margaret Sweeney of the U.S. Court of Federal Claims ruled that Fairholme was entitled to seek documents and testimony from the government in search of evidence on views inside Treasury on both the solvency of the GSEs and the expectations about the future profitability of Fannie and Freddie.


Cooper & Kirk is proceeding to submit document requests to the Department of Justice, which is defending the U.S. government. “We anticipate getting internal emails from the key players and being able to put them under oath and depose them,” says Thompson.


If Fairholme were to win its case in the U.S. Court of Federal Claims, it would not set aside the sweeps amendment, but it could lead to an award for losses claimed by Fairholme, according to Thompson.


The Perry Capital case seeks to have the U.S. District Court for the District of Columbia overturn the Treasury Department’s sweeps amendment. The suit asks the court to restore the prior capital structure with the rights of the junior preferred shareholders protected.


The sweeps amendment “fundamentally and unfairly alters the structure and nature of the securities the Treasury purchased. This blatant overreach by the federal government to seize all of the companies’ profits at the expense of the companies and all of their private investors is unlawful and must be stopped,” the complaint stated.


The Fairholme Fund and Arrowood Indemnity Co., Charlotte, North Carolina, are fellow plaintiffs in the suit titled Perry Capital LLC v. [Jack J.] Lew et al, Fairholme Funds Inc. et al v. Federal Housing Finance Agency et al and Arrowood Indemnity Co. et al v. Federal National Mortgage Association et al.


Perry Capital is arguing that the sweeps amendment violates the Administrative Procedures Act, according to Gibson Dunn’s Bopp. “What Treasury and the FHFA have done is create this conservatorship in name only, because once the [sweeps] amendment was entered into, it was no longer a conservatorship,” says Bopp. “It was a receivership and essentially a forced liquidation. This is inconsistent with the requirements of conservatorship.”


The Fairholme Fund, a party in the Perry Capital lawsuit, chimes in with support for the view that Treasury violated the Administrative Procedures Act when it adopted the sweeps amendment.


“This net-worth sweep is basically a de facto nationalization of Fannie and Freddie,” argues Cooper & Kirk’s Thompson. “It is without precedent in American history to sweep all the profits of a major financial institution into the United States government and to rewrite the rules halfway through a process.”


When Treasury amended the preferred stock purchase agreements on August 17, 2012, the department stated in a press release that the amendments will “make sure that every dollar of earnings each firm generates is used to benefit taxpayers.” Michael Stegman, counselor to the Secretary of the Treasury for housing finance policy stated in a prepared comment, “With today’s announcement, we are taking the next step responsibly winding down Fannie Mae and Freddie Mac, while continuing to support the necessary process of repair and recovery in the housing.”


In a January 22, 2014 speech in Las Vegas to the Structured Finance Industry Group, Stegman downplayed the profits the GSEs had earned in the prior year, noting the $86 billion of the profits were tied to one-time tax reversals and the recapture of loan loss reserves.


An April 2014 stress test analysis of Fannie Mae and Freddie Mac by the Federal Housing Finance Agency found that if there were another several financial crisis like the one in 2008, the two GSEs would require $190 billion to keep operating – an amount just slightly higher than the $187.5 billion Treasury had to provide the GSEs after they were placed into conservatorship. Stegman said the stress test results vindicate his earlier views about the GSEs. “And so, the case for getting on with housing finance reform centers on the undeniable fact that at its very core, the GSE business model—through bad times and good—continues to depend upon the support of the American taxpayer,” Stegamn said May 8, speaking in Orlando to the Federation of Municipal Bond Analysts Conference.


Thompson argues that the suit is “premised on the notion the conservator FHFA is bound by a statute to conserve and preserve the assets of the institution, and they’re doing just the opposite of that and sending all the profits over to Treasury every quarter.”


In addition, that statute says they are supposed to operate Fannie and Freddie in a safe and sound manner, according to Thompson. Instead, he says, “They are stripping out the capital so there is zero capital in the institutions--and that’s just precisely the opposite of a safe and sound way of running a financial institution.”


What does Perry Capital hope to achieve if the case is won? “If we are successful and we get a court to strike down the [sweeps] amendment, we would at that point negotiate with Treasury and FHFA as to what is the appropriate next step,” says Bopp.


“Striking the [sweeps] amendment is not a substitute for GSE reform, from our perspective--or anyone’s perspective,” he says. “Striking the [sweeps] amendment facilitates GSE reform.”


Status of the litigation


Where does the Perry Capital suit stand? In January, Treasury and the FHFA filed summary motions to dismiss the suit. In March, Perry Capital filed its motions and briefs for summary judgment against the government, and the government has replied to those briefs.


The court could render a decision on summary motion judgments as soon as late this summer or this fall, according to Bopp.


If the court rules in favor of the investors and declares the sweeps amendment illegal, what would it accomplish?


The FHFA and Treasury would likely appeal any such ruling. In the meantime, Bopp expects it would prompt Congress to resolve the issue through mortgage reform legislation in the new Congress next year.


Perry Capital would like to see reform legislation designed to bring in private capital.


“There’s a growing recognition or understanding of the issues involved in our lawsuits and what the [sweeps] amendment means. There’s a great likelihood next year, if there is housing finance reform, the legislation will resolve this issue and not have to wait for an appeals process to run in the courts,” says Bopp.


Odds for recapitalization


Ultimately the potential for further outsized returns on the GSE trade depend on whether the GSEs are recapitalized--either through the courts, by its conservator in conjunction with Treasury and the U.S. government, or under provisions in future mortgage reform legislation.


One veteran mortgage industry analyst remains highly skeptical of the chances that the GSEs will be recapitalized on any score by any of the venues where it is being pursued.


“I can appreciate in a world that suffers from the lack of sufficiently attractive investment opportunities that a number of institutional players are essentially buying a call option on Fannie Mae and Freddie Mac in one form or another,” the analyst says. “I would say that, to my mind, it’s unlikely Fannie Mae in my lifetime will be recapitalized as a public company,” he says.


The analyst ran through the various pathways to reprivatization and explained why in each case, he believes it is unlikely.


As for the courts, the analyst does not rule out some legal victories for the investors.


“I can’t rule out that the buy-side [activist investment funds], given the amount of capital they have, will never find a district court judge willing to provide an opinion in their favor,” the analyst says. “I just think that it’s inconceivable it would survive on appeal and certainly it’s inconceivable that the Supreme Court would want to take on something like that.


“From my own perspective, as someone involved more and more in litigation support, I can’t imagine that the Supreme Court would take that appeal and want to weigh in on it,” the analyst says.


“It’s exactly the kind of legal nightmare that Chief Justice John Roberts would want to avoid, where there is not good legal precedent, where the legislature itself has not definitively acted,” adds. “To my mind, this would not be a place where either the liberal or conservative wings of the court could find a happy medium. So I would think they would not take it.”


As for winning over Congress or the administration, the analyst also points out a lot of interests are arrayed against reprivatization. First, there are the clients of the GSEs. “Right now the leading mortgage lenders are very happy with Fannie Mae and Freddie Mac being exactly what they are,” the analyst says. “They have all paid out enough coin in the FHFA litigations and in the separate actions by Fannie Mae and Freddie Mac on their repurchase requests. The last thing they want to see is an empowered pair of GSEs able to even more strongly influence their business than they have previously,” the analyst says. “I don’t think any of the major lenders have any desire to deal in the marketplace with a recapitalized pair of GSEs.”


The analyst contends that a similar view prevails among financial market players who are clients of the GSEs.


“Certainly Wall Street is very happy for Fannie Mae and Freddie Mac to do exactly what they are doing--wrap deals and essentially support Wall Street trading activity without imposing their own profit-maximizing activities on the Street,” the analyst says. “I would read it as the Street and the major lenders emphatically do not want to compete again with the GSEs.”


The analyst identifies as a further barrier the clout of permanent constituencies of the GSEs--private mortgage insurers, the housing finance authorities and the nonprofit housing sector--that would certainly weigh in on any change in the status of the GSEs.


“All of these constituencies are very happy to deal with [FHFA] Director Mel Watt and would be less happy dealing with Fannie and Freddie as profit-seeking enterprises,” the analyst says.


“It’s very unlikely that the buy-side investors could ever muster enough political capital to neutralize the nonprofits, the mortgage insurance companies and the housing finance authorities.


“As I resolve in my mind who are Fannie Mae’s clients, who are Fannie Mae’s supporters, who have vested interests economically and permanently rather than just a flip--the way the buy side is positioning itself for some really terrific trade--all of them would prefer to see some form of the status quo prevail and not have any interest in seeing a recapitalization and re-emergence of GSEs as profit-seeking companies,” the analyst concludes.


A question of profitability


The underlying level of profitability at Fannie Mae and Freddie Mac, not influenced by short-term events, could figure in any outcome from the lawsuits filed by the investors. The reason for this, says Cato’s Calabria, is that there is “very much a possibility [the investors] win on the merits, but they can’t show damages [because of weak GSE profitability] and don’t win anything.”


For starters, Calabria discounts the huge profits the GSEs reported last year. “I think we all recognize that about half of the profit last year was a one-off event, whether it’s tax changes or whether it’s settlements with banks. Fannie Mae is not going to get billions more out of Bank of America,” Calabria observes.


Further, a segment of the earnings improvement has come from lowering loan-loss reserves, an unlikely source of any significant future earnings gains.


“You can only reduce your loan-loss reserves so many times,” says Calabria. “In fact, I would go so far as to say that if you compare Fannie’s and Freddie’s loan-loss reserves to Wells Fargo and Bank of America, I think there’s a good argument to be made that the loan-loss reserves [of the GSEs] are too low.”


Calabria is doubtful about the future earnings power of the GSEs.


“I’m probably in the minority on this, but I think the reality is these companies are going to be losing money sooner than people expect,” he says.


The investors who have taken positions in GSE common and junior preferreds “have to convince everybody else these companies are going to be insanely profitable,” Calabria says. “If it looks like they are going to be money losers, your bet is going to be a whole lot less valuable.”


Some investors may see it as a positive development for the equity investors that FHFA Director Watt has indicated he may encourage Fannie and Freddie to loosen underwriting standards in order to make homeownership more accessible to more borrowers. Watt wants to expand rather than contract the mortgage origination footprint of the GSEs.


“Watt is certainly in the camp of those who don’t see a problem with Fannie and Freddie as a model. He doesn’t think they should go away. He thinks they have a broader public purpose,” says Calabria.


“On the one hand, he’s got to try to expand their footprint in a way that he sees is keeping up their mission; but on the other hand, he’s certainly going to do it in a way that is going to ding profitability,” Calabria contends.


Calabria adds, “The irony here is that what actually might speed up reform in Congress is that Watt pushes them into money-losing positions.”


A spokesperson for the FHFA said the Director was not available for comment, but pointed out that he had in recent statements shed light on his views regarding where FHFA should place its focus.


In a May 13 speech at the Brookings Institution Forum on the Future of Fannie Mae and Freddie Mac, Watt pointed out that the FHFA does not have as part of its statutory mandate any role in housing finance reform legislation. “My guess is that there were many people who expected that I would start talking about reform legislation the minute I got to FHFA,” Watt said in his comments.


“I am well aware, and regularly express my belief, that conservatorship should never be viewed as permanent or as a desirable end state and that housing finance reform is necessary,” Watt said. “However, Congress and the Administration have the important job of deciding on housing finance reform legislation, not FHFA. Instead, our task is to continue to fulfill our statutory mandates, to execute our Strategic Plan and to manage the present status of Fannie Mae and Freddie Mac,” he added.


In FHFA’s 2014 strategic plan for the GSEs, released the same day Watt spoke at Brookings Institution, the agency lists as its number one goal for the GSEs: “Maintain, in a safe and sound manner, foreclosure prevention activities and credit availability for new and refinanced mortgages to foster liquid, efficient, competitive and resilient national housing finance markets.”


Yet, in the end, Calabria says that it cannot be ruled out that the full-court press of the GSE-long investors on Capitol Hill, within the administration and in the courts will ultimately succeed in terms of giving the investors the outsized return they potentially envision for their GSE shares. (Clearly, Fairholme has already scored big on that scale with impressive gains on paper.)


“As a general matter, the longer we go without GSE congressional reform, the better the chances that Fannie and Freddie can come back out,” says Calabria.


What are the odds that Treasury might do a reprivatization without congressional authority? “They will not [do a reprivatization] in this political environment, and I don’t think they would do that for years,” Calabria says.


“Certainly there’s a sense the further and further we get away from the crisis, assuming we don’t have another downturn in the housing market, there’s really a continued sense that, ‘Oh, do we really need to change anything? The old system wasn’t really that bad.’”


Time will tell.  MB


Robert Stowe England is a freelance writer based in Milton, Delaware, and author of Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, published by Praeger and available at He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..


©Mortgage Banking Magazine. Reprinted with permission.



Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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