How will GSEs Recapitalize if they are Privatized?
Written By: Joel Palmer, Op-Ed Writer
With the Trump administration’s published proposal to reform and reorganize parts of the federal government nearly a month in existence, stakeholders are now debating the nuts and bolts of making the broad ideas become reality.
This includes the administration’s proposal to “reform the federal role in mortgage finance.” A centerpiece of this section is to fully privatize Fannie Mae and Freddie Mac, which have been under federal government conservatorship since the financial crisis of 2008.
Among the many unanswered questions in the proposal is how to recapitalize the GSEs once they are released from conservatorship.
The administration plan call for the creation of a federal agency to provide GSE oversight, approve guarantors and “develop a regulatory environment that is conducive to developing competition amongst new private guarantors and the incumbent GSEs.”
A major part of this entity’s responsibility would be ensuring that the private GSEs and their competitors would be “adequately capitalized.”
But for that to occur, Fannie and Freddie will need to replenish the capital it has lost by paying dividends to Treasury since its conservatorship. The White House plan does not address whether dividend payments would be ceased to allow recapitalization, or if the GSEs would be privatized first, then have to rebuild their capital base.
"Almost no one in Washington questions the principle that large financial institutions should have adequate capital,” wrote Bill Giambrone, president of the Community Home Lenders Association (CHLA).
The Federal Housing Finance Agency (FHFA) took a small step toward recapitalization in December of last year when it reinstated a $3 billion capital reserve amount under the Senior Preferred Stock Purchase Agreements.
Under the original conservatorship agreement, Fannie and Freddie would have been required to have a net worth of zero by this year, in effect having no capital and providing all profits to Treasury in the form of dividends.
However, the move by FHFA in December was not designed for long-term capital stability. FHFA Director Mel Watt said at the time: “While it is apparent that a draw will be necessary for each Enterprise if tax legislation results in a reduction to the corporate tax rate, FHFA considers the $3 billion capital reserve sufficient to cover other fluctuations in income in the normal course of each Enterprise’s business. We, therefore, contemplate that going forward Enterprise dividends will be declared and paid beyond the $3 billion capital reserve in the absence of exigent circumstances.”
In his opinion piece, Giambrone stated that Congress should not be directly involved in any GSE recapitalization plan.
“It istoo much to ask Congress, which is best suited to addressing broad policy issues, to develop the details of a recapitalization plan for Fannie or Freddie — or even to determine the proper capital levels for these entities. That should be the responsibility of the two partners to the current GSE Preferred Stock Purchase Agreements — the Treasury Department and FHFA, which both have the needed expertise and the perspective.”
A number of recapitalization plans have been proposed for a variety of groups and stakeholders, many of them long before the Trump Administration’s government reform plan.
CHLA proposed a utility model, “in which the GSEs build up capital to enable them to exit the conservatorship and re-emerge as private entities, in which they perform a mortgage securitization and standardization role, supported by a government backstop of their MBS.”
Another popular proposal was offered last year by investment advisory firm Moelis & Company. Its plan “envisions a robust capital build, up to a total of $155 to $180 billion of core capital, through a combination of retained earnings, existing shareholder participation (e.g., conversion and/or participation in a rights offering), and third-party primary equity raises.”
What many of these proposals have in common is that they will take a number of years to execute, even if dividend payments were suspended indefinitely. That would require putting GSE privatization on hold, perhaps even until after the next presidential election.
GSE reform isn’t likely to be a hot campaign issue and there probably won’t be much voter pressure to get this done before the next round of elections. At the same time, the possibility of not getting it done before 2020 — with the potential for a changing of the guard in both the legislative and executive branches — means the president and Congress may not want to wait for recapitalization before executing its plan for mortgage finance reform.
About the Author
As an NAMU® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.
