WASHINGTON – The Trump administration on Thursday released its first formal plan to overhaul the housing finance system and begin the process of removing Fannie Mae and Freddie Mac from government conservatorship, where they have been for the past 11 years.
The plan would also allow the firms, which back more than half of the nation's home mortgages, to keep more of their earnings.
The objectives of the administration's plan, according to Treasury officials, are to create a limited role for the federal government in the housing finance system, enhance taxpayer protections, and increase the role of private sector competition. Accomplishing all of this will take legislative and administrative action.
The plan is 53 pages. It is long on broad, general proposals, but shorter on specifics. Recapitalizing the two mortgage giants and reinventing the $5 trillion housing finance market will be a lengthy and complicated process involving multiple stakeholders.
"This plan addresses this last unfinished business of the financial crisis in a way that preserves what works in the current system, protects taxpayers, and reduces the influence of the Federal Government in the housing finance system," the report says.
While it is up to the Federal Housing Finance Agency, an independent regulator, to decide when to release Fannie Mae and Freddie Mac from conservatorship, the Treasury plan offers a start to the process by suggesting a means to recapitalize the enterprises.
That plan does not include ending the ongoing net-worth sweep of all of Fannie and Freddie's profits, which is part of the Treasury's senior preferred stock agreement. Instead, the plan allows the firms to retain more earnings and thereby grow its capital buffers. The full dividend sweep was instituted by the Obama administration in 2012 and replaced a 10% dividend instituted as part of the enterprise's government bailout in 2008.
As of the end of Q2, 2019, Fannie Mae had made $181.4 billion in dividend payments to Treasury, and Freddie Mac had made $119.7 billion, according to earnings releases. Those exceed the amounts drawn from Treasury during the financial crisis by a collective $109.7 billion.
The Treasury plan says it will be necessary to keep the Treasury's preferred stock purchase commitment in place while legislation is pending. The plan also recommended that FHFA consider increasing the capital buffer at Fannie Mae and Freddie Mac, which currently stands at $3 billion in retained earnings. Raising the buffer would reduce the amount paid out to Treasury in the sweep. It did not say by how much the buffer should be raised, nor what the timing would be.
That buffer was instituted at the end of 2017, when tax reform threatened to put Fannie and Freddie in need of Treasury funds. Then-FHFA Director Mel Watt said the new buffer was "sufficient to cover other fluctuations in income in the normal course of each enterprise's business."
In an interview in May of this year, current FHFA Director Mark Calabria suggested that even ending the Treasury sweep entirely would not be nearly enough to recapitalize Fannie Mae and Freddie Mac to a point where they could be released from conservatorship safely.
"If you simply let them retain earnings, which is what the end of the sweep does, we're going to be years and years before they are ever going to have enough capital to leave, so it does seem like we're going to have to find other ways to raise capital," said Calabria. "Treasury has 80% of the [preferred] stock via warrants. ... One of the options on the table will certainly be a public offering, but we don't know that yet, but that's got to be an option on the table if we need to build that large amount of capital."
Fannie Mae and Freddie Mac have been very profitable in the past several years, thanks to higher fees they charge to lenders, higher quality loan portfolios and overall strength in home values.
There is nothing in the administration's plan to address the holders of Fannie and Freddie common shares. The expectation of this plan, however, has sent those shares soaring in the past few weeks.
The Treasury plan is less focused on recapitalization, however, and more dedicated to comprehensive housing reform. Treasury "does not believe a government guarantee is required," but said it would support legislation that authorizes an explicit, paid-for government guarantee of the payment of principal and interest of qualifying mortgage-backed securities.
After the epic housing crash over a decade ago – which was brought on by faulty loan products, predatory lending and lax underwriting standards – it would be very difficult to get private investors to come back to the mortgage market without some kind of guarantee against losses.
The administration's plan appears in line, very generally, with that of Senate Banking Committee Chairman Mike Crapo, R-Idaho.
Crapo's plan also calls for a backstop on mortgages, paid for by private guarantors. This would mean private companies backing the loans in addition to a securitization platform operated by Ginnie Mae, which currently securitizes the government's FHA and VA loans. Fannie Mae and Freddie Mac would be private guarantors, with their multifamily businesses being sold off and operated independently. Ginnie Mae would also provide a catastrophic government guarantee and operate a mortgage insurance fund.
"My priorities are to establish stronger levels of taxpayer protection, preserve the 30-year fixed rate mortgage, increase competition among mortgage guarantors, and promote access to affordable housing," Crapo wrote in a release.
In June, FHFA's Calabria asked Congress for the authority to charter new government-sponsored enterprises to compete with Fannie Mae and Freddie Mac. More competition is also on the administration's wish list.
The plan released Thursday is broad and complex, and will require lengthy negotiations among leaders in the administration, FHFA and Congress. Reform is unlikely to come quickly. One thing working against change right now is that the housing finance system is working and the housing market is not in any current danger.
"With concerns about the economy's fragility, trade wars, Brexit, Iran, North Korea and more, it is critical that the administration not disrupt one of the bright spots in the economy, which is housing," said David Stevens, former president of the Mortgage Bankers Association and former FHA Commissioner. "Whether we see next steps with greater detail remains to be seen given the focus on elections and economic stability."