How a new lease for life for mortgage giants

The way decision-makers and businesses balance the competing demands of taxpayer protection, shareholder profitability, and access to home equity will help determine who is on a mortgage and under what conditions.

Fannie and Freddie do not take out loans but buy them from lenders. They bundle them into securities sold to investors and provide collateral to make investors complete if the loan is defaulted.

This allows lenders to get their money back so they can lend again, putting them in touch with investors such as pension funds and hedge funds who would not otherwise invest in home loans. This role helped preserve the popular 30-year US fixed rate mortgage – something that few other countries have subscribed – including during the savings and credit crises of the 1980s.

It also requires unusual support from the government. The installation was based on an implicit agreement in the bond markets that the US government would bail out Fannie and Freddie if they encountered difficulties, given the importance of their intermediary role for the national economy.

This arrangement prompted the government to step in and take control of Fannie and Freddie at the start of the 2008 financial crisis, with listed companies facing heavy losses.

They had problems taking on increasing risks, mainly to compete with Wall Street businesses, and then because legislators wanted them to support a dwindling construction market.

They also speculated on the mortgage market itself, benefiting from the low cost of capital resulting from their implicit federal guarantee.
Fannie and Freddie, who, at the time of the financial crisis, had exhausted their welcome in Washington, were companies that also paid their leaders generously and used their weight in lobbying to block their efforts.

Obama

Administration officials who took over in 2009 did not know what to do with the so-called government-sponsored enterprises, or GSEs, but agreed that they should not simply be recapitalized and sent.

At a meeting in 2010, a senior manager of the administration attempted to write a comment on the disagreements joking that they were united by a public message that could be summarized on a bumper sticker, according to two people present. The slogan: "F- the GSE."

At a subsequent meeting, the White House economist

Austan Goolsbee

compared them to comic bandits captured and imprisoned in a cell at the bottom of the ocean. It would be foolish, he said, to let companies loose simply because they had promised to behave.

The administration began asking Congress to advance legislation to replace mortgage buyers and guarantors. All the ideas that seemed feasible had their own drawbacks. Many should have taken steps to increase the cost of credit for homeowners.

In the meantime, once real estate markets rebounded, Fannie and Freddie played an even bigger role than before the crisis. They went from heavy losses to multi-billion dollar profits, which the Treasury Department collected through a clear dividend at the time of their rescue.

The companies still held public stocks, which many investors considered almost worthless, but on which some asset specialists in trouble are betting. In 2012, the Obama administration replaced the fixed dividend of Fannie and Freddie with a new arrangement whereby almost all corporate profits would go to the Treasury, damaging investor bets.

With this move and the return of the housing market, some in Washington have started to defend the GSE, especially after their payments to the government far exceeded the cost of the 2008 bailout. Taking a page from the lobby group Fannie and Freddie before the crisis, some investors began paying non-profit groups and well-connected industry experts to argue that companies should not be dismantled.

They also sued, challenging as unconstitutional the government's claim on almost all the profits of Fannie and Freddie. For years, the courts have ruled against these lawsuits.

Some veterans of the industry have long maintained that the goal of replacing mortgage companies was not realistic. "The plumbing of the US mortgage market is going through these businesses," said

Daniel Mudd,

Managing Director of Fannie from 2005 to 2008.

By the end of the Obama administration, companies had made operational changes limiting the risks to US taxpayers. Their regulator has forced them to adopt stricter underwriting standards, reduce their investment portfolios and accelerate the sale of new instruments through which private investors would absorb certain loan losses. They also faced restrictions on executive compensation.

Although Republicans have long led the campaign to abolish business, when the finance director of the Trump campaign has

Steven Mnuchin

Interviewed for the position of Secretary of the Treasury, he included in this list of priorities a redesign of Fannie and Freddie.

As Secretary of the Treasury, Mr. Mnuchin addressed the issue not as an insider in Washington plunged into the battles of the 1990s and 2000s against the GSEs, but as a veteran of the financial markets. He had headed the mortgage bargaining

Goldman Sachs Group
Inc.

and later oversaw the recovery of a failed investor, IndyMac Bank, renamed OneWest Bank.

Mr. Mnuchin has invested in OneWest alongside

John Paulson,

A hedge fund investor known for his profits, bypassing the subprime mortgage market before his collapse, later bet on a revival of Fannie and Freddie. Paulson was also a major contributor to the Trump campaign and counted Mr. Trump and Mr. Mnuchin among investors in Paulson's hedge funds in 2016, according to the financial information provided.

"Clearly, a treasury secretary better informed of the real estate finance market than anyone else who has ever sat at his seat has always been worthwhile," said

Timothy Mayopoulos,

managing director of Fannie Mae for six years until last year.

"There has been a major shift from exploding the entire housing finance system and starting from scratch to focus on what should be preserved because it works and repairs what did not work," M said. Mayopoulos.

No political decision-maker incarnates change more

Mark Calabria,

a libertarian economist who has long called for the abolition of the giants of mortgage finance and rejected the idea of ​​making them piecemeal amendments.

Now, at the head of his regulator, the Federal Housing Finance Agency, Mr. Calabria will play a leading role in the implementation of the Treasury Master Plan.

The debate on what to do with Fannie and Freddie has evolved to become "What is the public policy problem we are trying to solve?" Said Mr. Calabria. "I see this as a positive gesture."

The survival of the mortgage lending companies gained momentum last week when a federal appeals court overturned a decision that justified the slippage of their profits in the Consolidated Revenue Fund. The court did not invalidate the sweep, but his decision suggested that the judges had criticized him. The administration decides to appeal or not.

Messrs. Calabria and Mnuchin called on lawmakers to undertake a major reform of housing finance. This is a daunting challenge for the presidential election cycle, especially after a decade of congressional inaction. The Treasury and the FHFA are preparing to privatize the companies through administrative channels.

"There is this problem that legislation in this area is difficult, and without it, there is no great tools" to resolve the current status of companies in addition to recapitalize them and free them from government control , said

Jacob Lew,

Secretary of the Treasury from 2013 to 2017 in the Obama administration.

The first step is to increase the capital that mortgage companies need to hold to absorb future losses, through a combination of retained earnings and new multi-year equity offerings.

After that, the government could also exercise mandates allowing them to acquire nearly 80% of the ordinary shares of the companies before selling them in the framework of a public offer.

The future activities of corporations may be limited so that they can continue to rely on a federal government. Under the Trump Administration Plan, they would pay fees for this support.

The privatization of Fannie and Freddie would be complicated because of the guarantee of their government. Critics fear that privatization will one day lead to the circumstances that led to the initial crisis, as companies are under pressure from shareholders or the government to take too much risk.

Policy makers could quickly recapitalize companies by offering stocks and attracting investors with dividends. But these dividends would eventually defeat the goal of having enough capital to protect taxpayers. In the meantime, the pressure to keep housing costs down could prompt the government to demand too little for a federal guarantee.

"Republicans defend the interests of shareholders. Democrats defend the interests of customers and no one defends the responsibility of taxpayers, "said

Lawrence Summers,

President Clinton's Treasury Secretary and President Obama's advisor from 2009 to 2011.

"It's a politically convincing formula: you're very effectively stapling America's most popular constituency, the owners, to shareholders.

The situation as a whole "resembles" Back to the Future, "said Summers, who began in 1999 to worry about the risks that companies could pose.

Mr Mudd, former CEO of Fannie, said he remained skeptical about a company's ability to serve two different masters: fulfill a public assignment of ensuring access to mortgage loans on all markets and at any time while satisfying private investors.

"There is one foot on the rolling paper of public policy, and the other on the rolling log of the operation of a commercial enterprise capable of raising its own capital", did he declares. "Sometimes these newspapers do not stay very close to each other."

-Kate Davidson contributed to this article.

Write to Andrew Ackerman at [email protected] and Nick Timiraos at [email protected]