Housing reform legislation: yes, it *is* that big a deal: Part 1, the GSEs and banking
Yes, it is that big a deal.
Zeus, this is a big deal
I almost never comment on legislation in process, because the factory puts so many twists in the sausage that speculations are largely pointless – and this legislation, for all its multiple motivations and antecedents, probably would never have been enacted but for the Fannie/ Freddie stock market price crisis.
Still – it’s here, it’s finished (this Reuters summary is as good as any), and it’s going to be signed quickly (the White House dropped its oft-repeated veto threats).
(Reuters) – With White House encouragement, the U.S. Congress on Saturday gave final approval to a housing rescue bill that will backstop Fannie Mae and Freddie Mac, create tougher oversight of the mortgage finance giants and spend billions to prevent home foreclosures.
The sweeping legislation, approved by the House of Representatives on Wednesday and the Senate on Saturday, has moved with uncommon speed and could be in place by next week. President George W. Bush and key lawmakers have said they hope the legislation will help restore confidence in a
When the history is properly written, HR 3221, the Housing and Economic Recovery Act (HERA) of 2008, will be seen as the most significant housing and banking legislation in at least two decades. In the coming days and weeks, you’ll have the chance to read multiple summaries of this legislation and its myriad parts.
As you do, bear in mind our Spinal-Tap-plus summary (it goes beyond eleven to … twelve!) of the main outcomes:
And the hush, was almost … deafening!
1. The GSEs’ Federal backing is now manifest
In the four years I’ve been posting about the GSEs, the story reached its climax on Saturday. Catastrophe being a precondition of fundamental financial reform, for nearly two decades, the Federal commitment to the Government Sponsored Enterprises (GSEs) was like the love children of Charles II – everywhere visible and never politically acknowledged.
The getting of bastards never goes out of fashion
The Federal government got away with this doublethink because for most of that era, the GSEs’ financial strength seemed impregnable; their smoothly-managed earnings rose from strength to strength, so whether and how Uncle Sugar would bail them out could remain a mystery.
Two weeks ago, the stock market wolf pack took a run at the GSEs, driving their share prices down to absurd levels. Perhaps they were motivated by two AHI blog posts that seem, in the words of Mickey Kaus, eerily prescient:
Huh? Does Krugman not know that Fannie Mae was a huge buyer of subprime mortgages, including mortgages from Angelo Mozilo’s Countrywide?
Here’s what I said, way back in January’s post, Who’s next?
Yesterday, wondering who might be next in the writedown game, I hauled out a June, 2007 story from Inside Mortgage Finance that reads much more scarily now than it did back when it was first published.
The GSEs were active buyers of subprime and Alt-A mortgages in 2007. Why were they doing this?
“While they are interested in growing their portfolios, OFHEO is not interested in letting them grow,” said Eileen Fahey, a managing director in Fitch’s financial institutions group. “Given the market over the past two years, they are interested in changing their portfolios and assuming new risks. They’ve moved away from the management of interest rate risk as their primary method of earning money and are shifting more toward credit risk.”
Translation: To replace the yield spread they were making on mismatched maturities, the GSEs have bought higher-yielding loans from less creditworthy borrowers.
Oh, great — just the thing we want them to be doing in the first quarter of 2007!
That’s just great, really great
“But what they can buy in terms of volume is restricted, so they are doing a balancing act of buying and selling.”
Translation: They sold lower-yielding higher-credit stuff and bought higher-yielding lower-credit stuff.
I’m just here to make you happy
The GSEs’ financial position became a crisis in July or the reason I highlighted in this June post, Capital, almost as good as money:
For financial institutions, capital is just as good as money, even if it’s not cash – and this matters enormously, because banks are judged sound based on their capital, whereas (like Bear Stearns) they can suddenly go bust when they run out of cash. Since we care about cash, we need to be alert for capital that isn’t cash.
Time for some new capital requirements
To be precise, if a company has tax losses, it doesn’t get a rebate from the Treasury (unless it ‘carries them back by amending the tax return from a previous year), so they can be carried forward and used against future taxable income. The deferred tax asset represents the estimated savings (losses times projected effective rate, plus unused credits like LIHTCs) – and they go on the balance sheet as a capital, implicitly ‘just as good as cash.’
These assets won’t be much use if Fannie and Freddie need to come up with quick cash.
Some (like LIHTCs) could be sold, although right now the LIHTC market is in a ground-hold.
Banks, for example, only get to count a portion of these assets toward their regulatory capital.
At the end of the first quarter, Fannie had deferred tax assets of $17.8 billion, equal to 45% of total shareholders’ equity, while they were $16.6 billion at Freddie, slightly more than [100% of] total equity.
To get to use these assets, which generally have lives of about 20 years, Fannie will need to generate about $50 billion in profit and Freddie about $47 billion. Between 2003 and 2007, Fannie posted net income of $19.7 billion while Freddie’s total profit was $7.4 billion.
If we use those figures as representative, Fannie Mae has a 10-year backlog of deferred tax assets, and Freddie Mac a 25-year backlog.
When it becomes unlikely that a company will use their deferred tax assets, they often write down a portion of them. Fannie and Freddie have yet to do so.
A Freddie Mac spokesman said, “We feel very comfortable about how we’re operating our business under the current regulatory environment.”
What else could one say? “You’re right, we should write these down, thanks for pointing it out”?
Shoulda done it long ago, shouldn’t we?
Well, that that peekaboo is over. The Federal guarantee has been chased out of hiding: the GSEs are too big to fail, and we’re going to protect them if we have to.
Any doubts?
Fannie Mae and Freddie Mac, which each have a $2.25 billion line of credit with the Treasury, would see their current government loan limit raised until January 2009.
If the companies’ financial condition were to reach a crisis, Treasury could take an equity stake in either company. That power, too, would expire in January 2009.
* Treasury can buy up to $25 billion worth of Fannie/ Freddie securities.
* The Federal Housing Administration can refinance up to $300 billion of Fannie/ Freddie securities.
* Their $2.25 billion current Treasury lines are significantly expanded through 2008.
Time will tell what this costs the taxpayers:
* There is a better-than-even chance that the emergency measures will not be needed, meaning there will be no cost to taxpayers. If the lifeline is required, the Congressional Budget Office said, there is a 5 percent chance that the companies may need $100 billion but more likely would need $25 billion.
Personally, I bet it’s zero – just like the Chrysler loan guarantee of nearly thirty years ago – which was a similar case of the government backstopping with credit an entity with long-term viability but short-term balance sheet weakness.
2. It’s a new, muscular Fed/ treasury that will have a strong role
I’m from the government and I’m here to protect you
The role of protector will be played by a new entity, the Federal Housing Finance Agency (FHFA), who’s going to have substantial new powers that it will deploy as permanently advised by the Federal Reserve Board.
I just offer advice … oh, and money, too
This means an end to OFHEO, the Office of Federal Housing Enterprise Oversight, which did yeoman service despite being both legally toothless and pilloried by the GSEs.
3. Banking on value is the norm
I’ve previously posted about Banking on Value and how it’s a fundamental revolution in banking governance – indeed, a financial and regulatory coup.
As I put it in my essay for Recap:
The revolution that occurred over the Saint Patrick’s Day weekend of March 15-16 was quiet, swift, and decisive – so much so that even today the major media do not realize just what’s happened.
In funding JPMorgan’s hasty adoption of Bear Stearns and backstopping the major banks, the Federal Reserve (with the support of four other global central bankers) called a halt to the runaway markdowns plaguing our industry, by allowing the beleaguered institutions to pledge – not sell – their complex if illiquid assets in exchange for cheap short-term Federal cash.
Unlikely revolutionaries
In so doing, the Fed’s move changes the rules for every major institution in ways that will permeate all asset classes, including residential rental. Those banks that first reorient in this new environment by establishing a defensible value for their residential assets will be able to gain a liquidity advantage, and therefore a huge buying and business growth advantage, over their still-dazed competitors.
Everything I said in those posts is even truer now – in spades.
We’re holding the cards
4. Everybody’s a bank now, and everybody’s regulated
Back in April, in State of the Market 7: Banking on Value, I wrote:
After Bear, the capital markets will reform themselves through the power of the Golden Rule – whoever provides the gold makes the rules. With the Fed providing the gold, the Fed will be making the rules. Those rules, as envisioned by Treasury Secretary Paulson, will be much broader oversight of financial institutions, and much more granular information concerning their investments.
In the world after Bear, with the Fed banking on value, if you want to bank, you’ll need defensible values.
As I wrote last week, by the time the Fed and Treasury are done defining the new rules, everybody’s going to be doing it their way, because it’ll be their way or the bankruptcy way.
Don’t worry, I’ve got a different highway
Be sure to come back tomorrow: I’m just beginning to list the changes.
Same time tomorrow?
[Continued tomorrow in Part 2.]
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