Seizing the “10 Percent Moment”

It is time to put to rest the fictional accounting that condemns Fannie Mae and Freddie Mac to perpetual status as wards of the state awaiting dismantlement. Both have reached their “10 percent moment,” removing a perceived barrier to long-term reform of the government sponsored enterprises (GSE).

The idea of the “10 percent moment” was laid out two years ago by Alex J. Pollock, a former president and CEO of the Federal Home Loan Bank of Chicago, now a senior fellow at R Street, a Washington think tank. Simply stated, Fannie and Freddie have met their debt obligations to taxpayers.

The Housing and Economic Recovery Act (HERA), which infused the GSEs with $187.5 billion in public funds and placed them in a conservatorship, stipulated that the preferred stock the government received in exchange for the bailout money must achieve a 10 percent rate of return. This week, following some rigorous review and recalculation, Pollock said this milestone was reached.

“Even after its fourth quarter 2017 loss, and counting the resulting negative cash flow for the Treasury in 2018’s first quarter, we conclude that Treasury’s IRR (internal rate of return) on Fannie is 10.04 percent,” Pollock wrote in a March 6 blog post. Freddie already had its “10 percent moment.”

So, now that the GSEs have paid back the U.S. Treasury and the required 10% compound rate of return, the Treasury Department and the Federal Housing Finance Agency, the GSEs’ conservator, have a free hand to move ahead in ending the ten-year-old conservatorship and implement long term reforms – the most important of which require no action by Congress.

Among the reforms Pollock sees as essential for protecting taxpayers and creating a more sustainable and stable secondary mortgage market system are strict capital requirements for the government sponsored enterprises (GSEs), a fee the GSEs would pay to Treasury for its credit support, and adjustment of Fannie and Freddie’s mortgage backed security (MBS) guarantee fees.

The details of these proposals and others can be debated and worked out in due time but it makes eminent sense to make sure too-big-to-fail institutions have adequate capital. It also makes sense to stop the guess work about the meaning of “implicit” versus “explicit” government guarantee and establish mechanisms to cover the assistance that policymakers would surely see fit to provide the GSEs to stave off some future economic catastrophe.

Changes in tax law, like the one just enacted, can skew the GSEs balance sheets on a short term basis. However, Fannie and Freddie were actually more stable than initially thought going into the 2008 financial crisis. They have been posting strong profits very consistently for nearly six years. Had their quarterly revenues not been vacuumed up by Treasury in the Net Worth Sweep since 2012, they would also have billions in buffer capital. Now that they have paid back taxpayers and achieved 10 percent rate of return, it is time to end the Sweep so they can recapitalize. In the meantime, continue with reforms that have made the GSEs leaner and more disciplined entities owned once again by shareholders.

None of these common-sense steps require Congress to act. HERA empowers FHFA, working with Treasury, to do all of this. Now is the time to use that authority and end the GSEs’ state of limbo and Treasury’s raid on their quarterly earnings.

The alternative is to wait for Congress to act. More than half-way through the 115th Congress, the idea seen as most viable has not even been formally introduced. Its architects, retiring Sen. Bob Corker, R-TN, and Sen Mark Warner, D-VA, continue to make adjustments to attract bipartisan support. So far, conservatives are wary that the bill would put taxpayers on the hook for MBS offered by private sector guarantors the draft measure envisions springing up.  Democrats, meanwhile, see the eventual elimination of Fannie and Freddie envisioned by the measure as the beginning of the end of the 30-year mortgages and government support for affordable housing for low-income people, which they hold dear.

Exposing taxpayers, making home finance less accessible and abandoning policies to help struggling Americans afford housing fly directly in the face of housing reform principles stipulated by Treasury Secretary Mnuchin. So why would the Trump Administration wait for lawmakers who will likely become more action-averse as this year’s volatile mid-term elections draw closer to come up with a bad bill that will not pass? It would be better to stay the course with successful reforms undertaken in recent years, embrace sound and pragmatic ideas embodied by proposals from Pollock, Moelis &Co., and others, and use statutory authority to put in place federal housing finance policy that is sound and fair for all stakeholders.  It is time to seize the “10 percent” moment with a 100 percent commitment to putting a coda on the 2008 financial crisis.