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Investors Unite Teleconference: Lack of Leadership and a Brain-Drain Putting the Brakes on Unwinding the Conservatorship?
Friday, October 31st, 2014
Investors Unite Teleconference: Lack of Leadership and a Brain-Drain Putting the Brakes on Unwinding the Conservatorship?
As part of our work to engage and educate investors, Investors Unite hosts regular conference calls featuring experts and other voices of authority on issues surrounding the conservatorship, Fannie Mae and Freddie Mac, pending legislation and other matters. Our latest call featured Dr. Cliff Rossi and Matt Seu who discussed Dr. Rossi’s paper “Forging A Path Out of Conservatorship for Fannie Mae and Freddie Mac.”
Dr. Rossi is the founder and principal at Chesapeake Risk Advisors and Executive-in-Residence and Professor of the practice at the Robert Smith School of Business, University of Maryland. Prior to entering academia, Dr. Rossi had nearly 25 years of experience in banking and government as a senior risk management expert for the largest financial services companies and for Fannie Mae and Freddie Mac. Matt Seu serves as a principal with actualized consulting focusing on mortgage and fixed income practice areas and managing the firm’s accounts on the GSEs. Prior to this, he served as Vice President of Freddie Mac, where he focused on large scale businesses and technology change efforts. Mr. Seu was responsible for redesigning a significant portion of Freddie Mac’s operational infrastructure and served as head of the corporate enterprise data program.
What’s most exciting is how these calls are growing. This latest call drew more than 140 listeners from among our investors, the media, and officials at Fannie and Freddie, and Capitol Hill in Washington, D.C. These calls are quickly turning into “Must Listen” discussions for stakeholders as a platform for serious reform.
Below are highlights from the call. We encourage you to join the conversation on the Investors Unite Discussion Board.
Housing Market Languishes While Congress Fiddles
Dr. Rossi: “We are six years after both GSEs entered conservatorship, and effectively the housing market remains in a form of financial limbo or suspended animation. To a large degree, congressional inaction over this period, notwithstanding what we’ve seen with regard to many bills that have come out, such as Johnson-Crapo, but it has effectively forestalled any serious plan for bringing one or both of these agencies out of their conservatorship. A lot of this has to do with the sheer complexity of GSE reform, coupled with a nearly unprecedented schism between the political parties, and explains really, in my opinion, why comprehensive GSE reform is just not possible in the near term. Meanwhile, the US housing finance system continues to languish in a form of limbo that poses considerable uncertainty to both private investors and potential home buyers.”
With Little Change For A Legislative Solution, FHFA Should Use Its Authority To Act
Dr. Rossi: “In my opinion, the right outcome for GSE reform here is it would be comprehensive legislation addressing both Fannie and Freddie, but as I’ve said, it’s really unlikely to occur, but a solution that could bring private capital back to housing markets would significantly limit, but not eliminate, taxpayer contingent liability and address the issues that precipitated the demise of the GSEs in the first place is quite feasible. That solution actually is possible within the Housing and Economic Recovery Act of 2008’s legislation by granting FHFA, the regulators of Fannie and Freddie, the authority to bring them out of conservatorship.”
A Carefully Crafted, Thoughtful Exit From the Conservatorship That Does No Harm
Dr. Rossi: “So if you think about designing an exit from conservatorship for Fannie and Freddie, it would have to be carefully crafted in order not to disrupt the mortgage market, and this is why I don’t believe receivership would be an appropriate alternative here. As mentioned in what I’ve said earlier, an outcome that would be less likely to disrupt markets would be this conservatorship idea, and the keys to unwinding the conservatorship actually lie in meeting the following requirements: development of a recapitalization plan that complies with FHFA’s capital buffers for both agencies, and that could actually be accomplished by canceling the treasury senior preferred stock, declare it as paid back by recharacterizing these past payments of the 100% profit sweep less the 10% dividend sweep that’s been done as a pay down of the principal that could retire that treasury stock, and the value from that cancellation then would actually flow up through to the remaining common stock and would benefit the treasury as owner of 80% of the common shares through the warrants that they still would actually hold. In addition to this, other components of the plan would include development of a set of stringent risk-based capital requirements that would be phased in over a specified period of time that I alluded to above, termination of the sweep of profits from the GSE to treasury, strict executive compensation requirements and post via FHFA, and an accelerated wind down of both GSEs’ retained portfolios. It’s my opinion that following such a course of action with these principles in place not only is a really pragmatic approach to the GSE situation, but one that would ensure taxpayers do not face another bailout of either of these agencies and yet would revitalize the housing market and facilitate private capital back into the mortgage market.”
Fannie & Freddie Brain-Drain Contributes To Inability To Plan For Their Future
Matt Seu: “I think if you’ve paid attention to both Fannie and Freddie over the last several years, it’s not hard to realize that they’ve had a lot of turnover with key leadership, be it because of controversy or self-selecting out; there’s just not been a lot of continuity and so because of that, there’s been a lot of change in directions, and to be frank, there’s not been an endgame for either of them in place; in fact, Cliff’s use of the word ‘limbo,’ I think, is appropriate. They both are out there trying to figure out what they’re going to be next, and when you’re not able to see a beacon ahead of you, it’s going to be tricky to get there. So I think that’s a challenge, in general, and probably related to that and with what I’ve said about the leadership change is it’s been tricky for them to retain good talent. I think early on in conservatorship, some of the talent was forced out, some have opted out, but it’s going to be important that they start to grow additional leadership from within and I don’t think they’re going to be able to do that until they’ve been given what the endgame looks like and it’s attractive to stay there and grow. Second to that, I think both companies have operations and technology that are old and aging, and as much as they’ve been trying to modernize, it’s tricky to do that not knowing exactly what you’re going to do, be it a guarantor, be it part of a conduit structure, what have you, and clearly there’s been a stake in the ground with the new securitization company being put in place as a joint venture, but I think that once the final determination of what happens to them is in place, it’ll be very clear and at that point, they can both focus on modernizing what they do, improving and enhancing to the intellect that they’ve got, and at that point, I think we can see business as usual.”
A Way Out, If FHFA Exercises Its Authority
Dr. Rossi: “If you look at the numbers in terms of net treasury proceeds from the GSE investment so far, and you look at just the treasury, the preferred stock investment that they made, which is approximately $190 billion or so, the dividends and the profits paid already is about $209 billion or $210 billion or so. And then there’s a preferred – if you put some evaluation on the preferred shares that are out there at about another 200 or so, what I suggest could happen is that the shares could actually become part of the recapitalization plan where that is that the government could declare immediately that the profits tomorrow cease flowing over to treasury and from that part, they could actually then use these shares to then be able to recapitalize the firms. I want to be clear about one thing, though, that in doing so, I’m not at all suggesting that this is going to happen overnight, but in fact in the paper, I suggested it’s probably more like a three to five-year type of period.”
Pre-2008 Wrongs Have Been Righted In The GSEs
Dr. Rossi: “We accelerate this recapitalization plan I’m talking about by basically, right off the bat, canceling treasury senior preferred stock, declare it right now as paid back, recharacterize any past payments of the profit sweep, taking out the 10% dividend sweep that’s already been done as a pay down of the principal, and that would retire the treasury stock. By doing that – and it’s my belief, this could actually be a legacy play for the administration as we’re looking over the next two years, because it would effectively make the taxpayers more than whole on the investment, while at the same time, putting both of these agencies back where they were – and I know there are a lot of people that sit on both sides of this conversation in terms of whether we should be opening Pandora’s box and putting the GSEs back into the same structure that they were leading into conservatorship, my argument is that almost, or if not all of the issues that brought them into conservatorship have or will be addressed by the time they would come back out of this recapitalization plan, thereby another aspect for the taxpayer is that it would create a negligible contingent liability for any future problems. Let me just put it this way: if both of those entities had had strong regulatory oversight leading up to the crisis, if they had had a small or no retained portfolio, if they had had strong underwriting practices going on within the industry during that period of time, or if they had had strong capital requirements maybe no more than 5%, they would have survived the financial crisis. I think a lot of people don’t realize that there have been a number of things that have come along since 2008 to completely address the deficiencies that were in place with both agencies at that time.”
Do Bureaucrats Fall Asleep Counting Fannie & Freddie’s Dividends?
INVESTOR BARRY WEST: “How would Treasury defend once they’ve gone over this threshold of collecting the principal and the 10% interest? How would Treasury defend taking more than what was actually put up? Thank you very much.”
Tim Pagliara: “How can the Treasury defend taking more – I mean, they can’t; it’s indefensible and they don’t have much of a conscience or having trouble sleeping [Laughter] at night doing it up to this point, and they continue to try and defend it in the court system.”
You Know It; They Know It: Congress Is Broken. And FHFA Has The Authority To Unwind The Conservatorship
Dr. Rossi: “FHFA has the authority to bring both entities out of conservatorship, and again, it’s something that doesn’t get talked a lot about and I think it hasn’t for a number of years, because Congress is trying to deal with it legislatively and has been unsuccessful; and I think we have to step back away from this. I, too, embraced the legislative solution at one time and so we’ve kind of come to the realization that practically speaking, another way for it has to be thought through and I think this idea of bringing them out of conservatorship is the best way forward to try to revitalizing the housing market.”
HERA … Wait For It … Has the Authority To Unwind The Conservatorship
Dr. Rossi: “The thing that you have to read is this Housing and Economic Recovery Act of 2008, which is a little tedious, but that serves as the basis for the authority that the FHFA was granted by Congress. And if you read it, they actually do have their specific language in HERA that stipulates that FHFA, when it deems it appropriate – now, I’m paraphrasing – has the ability to unwind the conservatorships if they deem it in the best interest of those companies. There’s a potential sticking point; there is a section in there, Section 6.3, I believe it is, that also goes into some detail that the amendments that you are all aware of around the preferred stock purchase agreements that were established between the government and the agencies that there’s a provision in there that says that any such actions to, in this case, let’s say, unwind the conservatorships would have to do so in a way that does not disrupt or materially harm investors in mortgage securities, the GSE securities. I think that provides still a fairly – and I’m no legal scholar on this, but my read of that is that there’s sufficient room in there to suggest that that’s not an impediment to bring them out of their current state.”
Continuity At The Top Is The Best Course For the Future Of The GSEs
Matt Seu: “Things right now appear to be very much business as usual as they were 10 years ago. They’re operating a business in a similar way. Now, granted not retaining investments in the portfolio, but think about where you were if you were an employee six years ago, you are having town hall or all hands meetings where someone that you’d never seen before, regulator comes in and says, ‘We’re going to run your company right now.’ Now, people left right away and as the revolving door of new management were appointed and came in, thinking they were going to be able to solve all the problems, that – I guess I would say that junior executive level up through some of the long-time executives started to pare off and leave. Without that continuity at the top, without that direction, without any understanding of where you’re going to be in five to 10 years, couple that with a very significant change in compensation, that led to a big accent. And I think that for me it would be very difficult to think about how you’re excited about doing business in a conservatorship and so I think that that’s going to be a big challenge going forward. I think they’re going to have to energize, they’re going to have to figure out who are the core group of executives that they need, and what are they going to do in 10 years when they haven’t had that injection of smart, young folks that forever were part of the core of both of them. I can tell you that 10 years ago, it was a great place to work, both of them. So you would see folks from very well-known academic institutions going to work at both places, and quite honestly, in some regards it was a little bit more like Wall Street in Washington DC, which is a little bit unusual, but I do think they’re going to have to address that. It’s not in the press as much, but if you do walk the halls, it’s very obvious.”
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