Although the NAR has reportedly called Calabria’s comments “aspirational,” we think they lay out hard-headed options to concluding the GSE conservatorships. Only two goals appear inviolable: the 30-year FRM stays and as much taxpayer risk as possible goes away. As we map out different paths to these goals under current law – and there are several thoroughly plausible ones – we foresee significantly different ranges of market winners and losers. For many of them, winning and losing is a franchise-value battle under current law not requiring the statutory change many now assume provides all the protection they need.
To know who wins or loses and by how much, one has to map out each of the conservatorship rewrites that can be completed under current law with an eye to the following questions:
- How much capital must successor entities have? As we’ve noted, the FHFA capital proposal leads to a $181 billion shortfall. However, as we showed, FHFA’s proposal is nowhere near the bank-like capital it purported to mandate. Calabria has recently talked a truly bank-like game, suggesting a 5% ratio that, while still below big-bank leverage ratios, approximates the best-possible risk-based ratio for low-risk mortgages. Even so, this is a $274 billion reach, or so he has said. How much capital how fast and how different risk structures are scored will determine not only the pace of privatization, but also a wide swath of the redefined U.S. mortgage market.
- How much credit enhancement and from whom? For example, under the bank capital rules, different types of collateral and/or credit enhancement get very, very different amounts of capital credit. MI is viewed favorably at the loan level, but is wholly discounted under stress test and for secondary-market obligations. Nonbank credit enhancement gets zero capital credit unless the provider is a regulated securities firm. The treatment of insurers under the banking regs is equivocal, but generally acceptable as long as the insurer isn’t monoline. CDS and other instruments also offer a lot of potential capital relief if the banking rules are followed – and, of course, lots more if not so much.
- Securitization Structures: How fast the GSEs emerge from conservatorship and in what form is determined not only be the capital accorded to credit enhancement, but also by that applied to remaining risks retained by whatever the GSEs become. It seems clear that the Administration and FHFA want if at all possible to end simple P&I MBS with a 100% USG implicit guarantee. Tranched MBS with lots of capital-market participation based on CRTs are clearly Treasury’s preferred outcome. However, questions arise not only over how these fit into the “bank-like” capital framework, but also the actual construct of the investing market. Capital-market structures get a good deal of capital recognition in the banking rules, but only in complex ways that prevent big banks from taking first-loss positions. Would this apply to new GSEs? If not, who’s in for the first loss and does this result in enough market capacity to support the TBA market? If not, are Plan B post conservatorships required? We think so because of capital-market capacity for high-risk positions that, even with an effective guarantee and a price subsidy, are hard for the conservatorships to pull off at the height of the business and financial cycles.
- What Goes Where: As we have noted, the path to new-style GSEs passes through a complex set of receivership and limited-life regulated entity (LLRE) options. One or both GSEs could go into receivership, creditors could win or lose thereby, securitizations could emerge out the other end in new UMBS, the CSP could go its own way, and pretty much all the obligations, assets, and products the GSEs now have would go where FHFA and Treasury want based on how much capital each thinks surviving entities must have and the role anticipated for the new-age GSE or GSEs. One GSE could also go into receivership and stay there while the other goes into receivership, is cherry-picked, and turns into an LLRE. Which is which will make more than a modicum of difference.
- Products and Profits: FHFA has considerable discretion to move activities between GSEs in various charter options and to expand or end different business lines in any area not specified by law (e.g., multifamily finance). Calabria has made it clear that he aims to end an array of “pilots” that competitors think transgress HERA’s new-product restrictions. We expect these to end in the near term. However, the ultimate structure of what happens to the conservatorships will determine where even the activities otherwise stipulated in law end up – for example, a GSE in receivership is a very different enterprise than a surviving charter or successor company. FHFA has almost unlimited statutory authority to redefine the entire GSE business model in LLREs.
- GSE Resurgent: However, there are also charter options that would permit one or both GSEs to be reconstructed at least partly as before. Which survives how and under what type of USG backstop for which product offerings is a critical strategic decision.
IPOs along the way could raise enough capital for some of these options and nowhere near enough for others. Similarly, some of these options permit multiple GSE-like charters along the lines Calabria contemplates; others don’t. Some of these options clear the way for MI and private credit enhancement; others threaten its survival. Some provide unique opportunities for large banks to regain a mortgage edge. Most directly threaten small lenders, but a surviving GSE as a utility securitization machine could go a long way to satisfying smaller lenders, many of the mortgage trade associations and all but the largest banks and capital-markets competitors.
In short, it’s open season. Treasury has tremendous influence over the process because it and the White House define the political context, with Treasury also holding the PSP contract which gives it capital dibs on the GSEs unless or until it’s willing to let go. Treasury can’t, though, do anything even with its contractual power to which FHFA is opposed. But, under current law and given the current confluence of market and macroeconomic factors, Treasury and FHFA have far-reaching control over the conservatorships and what’s to become of them. Once Treasury and FHFA chart this course, they will set sail with considerable strategic impact on Fannie Mae, Freddie Mac, and the entire construct of U.S. housing finance.