Finance reform may be coming, but not soon enough for some

by Kimberly Greene17 Jul 2019

Although both the U.S. Treasury Department and the White House are eager to end the conservatorship of Fannie Mae and Freddie Mac that has been in place since 2008, the current administration is becoming cautious of making any bold moves before the 2020 election, lest it have any adverse impacts on the mortgage market.

Officials at the Treasury Department and in the White House see freeing the GSEs from federal control as being incredibly complicated, and that the process needs to be done slowly and deliberately, according to people familiar with the matter, Bloomberg reports.

The effort gained steam earlier this year, and Federal Housing Finance Agency Director Mark Calabria made his thoughts on the matter clear in his first annual report to Congress: the time for comprehensive finance reform is now. Since then, however, the trade war with China has taken up a lot of bandwidth for Treasury Secretary Steve Mnuchin, a situation that has a lot of people concerned about the knock-on effects for the U.S. economy, making it even more important that the housing market remains as stable as possible.

“The president earlier this year instructed the Department of Treasury to develop a comprehensive plan for bold reform,” White House spokesman Judd Deere said in an email statement. The National Economic Council, Treasury, Federal Housing Finance Agency and others “continue to work together on this presidential priority and anything to suggest otherwise is false.”

Even though this is a “presidential priority”, there is also a presidential concern that this slow-moving effort could have unpredictable effects, including making it difficult for borrowers to get loans in the time leading up to the 2020 presidential election, people close to the matter told Bloomberg. The health of the economy plays a big part in any reelection bid, and the housing market has a direct impact on the economic outlook.

One plan for post-conservatorship finance reform would require Fannie Mae and Freddie Mac to raise more than $200 billion in capital in order to ensure that they have enough of a buffer in the event of an economic downturn, which would likely result in the biggest share offerings ever recorded.  As it stands, the conservatorship ensures that Fannie and Freddie benefit from excellent credit ratings as well as a government line of credit, which means that financing is always available for mortgage lending, and that helps keep rates low for buyers—hence the need for the capital buffer.

If the companies were to lose the backstop, it is unclear how mortgage bond investors and lenders might react. To make things even more uncertain, Craig Phillips, one of Mnuchin’s top aides, left the department in June. He took the lead on several domestic financial policy initiatives, including freezing Fannie and Freddie from conservatorship, and another direct point person on the matter hasn’t yet been identified. Phillips was one of the architects of a draft report for the reform process, although he left the department before the report was completed. The report has yet to be released, despite Calabria hoping it would be presented before the end of June. The new expectation is that the report will be released before the fall.

Calabria’s appointment was thought to provide some momentum for the reform initiative, after he made a series of appearances this spring where he gave quite a bit of attention to the issue. Calabria, a former economic adviser to Vice President Mike Pence, even said that he wanted Fannie and Freddie to start raising capital by Jan. 1. The president even commented at a conference hosted by the National Association of Realtors (NAR), calling the situation a “pretty urgent problem.”

Fingers are crossed for hedge funds and other investors who own shares in the two companies, as the stocks have more than doubled this year, and they could reap the financial rewards.

Even if complete reform doesn’t happen before next year’s election, the FHFA and the White House can make some strides in that direction. Reducing the impact that Fannie and Freddie have on the overall mortgage market would help to reduce the risks to those companies once released from conservatorship. Calabria could also impose a formal rule that states exactly how much capital the companies would have to hold. The Treasury and the FHFA could also put a stop to the policy requiring Fannie and Freddie to send almost all of their earnings to the Treasury, although that’s unlikely to happen this year, a source close to the matter told Bloomberg.

 Fannie Mae and Freddie Mac keep the housing market humming by purchasing mortgages from lenders and packaging them into bonds that are then sold to investors, who are guaranteed interest and principal. This process keeps the mortgage market liquid and provides financing that makes homes more affordable than they would be otherwise. The companies fuel around $5 trillion worth of home loans.

This stake has made policymakers and lawmakers alike unsure how to proceed in the aftermath of the 2008 financial crisis, during which the companies were taken over my regulators and bailed out by taxpayers to the tune of $191 billion. Since then they have become profitable again, and have paid more in dividends to the Treasury Department than they received in aid.

Fannie slid as much as 11% before rebounding to $2.70, a 4.2% decline. Freddie fell as much as 10% and stood at $2.61, down 3.3%. The declines were the biggest since Mnuchin told Bloomberg in June that he didn’t want to release the companies from government control without reform. Mnuchin supports the backstop, and Calabria’s idea of potentially bypassing Congress. Still, he said that the administration wouldn’t allow the companies to build up a ton of capital and then release them into the wild, hoping for the best.

There is no quick fix. And so, we wait.