Washington, D.C. – Former Clinton administration Under Secretary of Commerce Robert Shapiro, who also advises senior members of the Obama administration, made the following comments on the release of Freddie Mac’s quarterly earnings:
“Freddie Mac has announced its new earnings, which the Treasury will promptly ‘sweep’ into its own accounts. Freddie should be able to use its own earnings to recapitalize its operations, and help Americans looking for mortgages or affordable rental housing.
I’m encouraged by FHFA Director Mel Watt’s comments today that the conservatorship ‘is not a desirable end state’ for Fannie Mae and Freddie Mac. I agree with him that ‘Congress needs to tackle the important work of housing finance reform,’ – preferably by ending the current conservatorship and recapitalizing both enterprises.”
Shapiro recently co-authored a new report, discussed in POLITICO, Bloomberg and the New York Post, which lays out a four-step path to recapitalize Fannie Mae and Freddie Mac, restore their support for middle-class homeownership, provide $100 billion in new affordable housing funds, and create more than 175,000 new jobs.
Freddie MacFor All Americans By Recapitalizing Fannie Mae And Freddie Mac
by Robert J. Shapiro and Elaine C. Kamarck
From 1938 to the financial crisis of 2008-2009, the Federal National Mortgage Association (Fannie Mae), joined in 1970 by the Federal Home Loan Mortgage Corporation (Freddie Mac), supported steady, strong increases in homeownership and access to affordable housing for millions of Americans. The share of American households owning their own home increased from less than 43% in 1940 to more than 69% in 2005, at which time Fannie Mae and Freddie Mac owned or guaranteed about one-half of an estimated $12 trillion in U.S. mortgages. In recent decades, Fannie and Freddie also undertook targeted efforts to expand affordable rental housing for moderate-income households. All of these activities were disrupted severely from 2007 on by the sharp drop in both housing prices and the value of many mortgage-backed securities (MBS) held by the two enterprises. In September 2008, the Federal Housing Finance Agency placed them under conservatorship, and the U.S. Treasury has to provide financial assistance to both companies which ultimately totaled $187 billion.
Since then, Fannie Mae and Freddie Mac have operated under direct government control and supervision. While both enterprises have restored their profitability since 2013 and repaid the government and taxpayers $239.1 billion, the Treasury holds warrants for 79.9% of the stock in both enterprises and continues to claim or “sweep” all of their profits into its own accounts. This policy limits their ability to promote home ownership, which declined over the last decade from 69.1% to 63.7%. The government’s current approach also limits sharply Fannie and Freddie’s capacity, as directed under the Housing the Economic Recovery Act of 2008 (HERA), to expand access to affordable rental housing or home ownership by low-income households through their Housing Trust Fund (HTF) and Capital Magnet Fund (CMF).
This study presents a strategy for ending the current conservatorship and majority government ownership of Fannie Mae and Freddie Mac in a way that will enable them, once again, to effectively promote greater homeownership by average Americans and greater access to affordable housing by low-income households. This strategy includes regulation of both enterprises to prevent a recurrence of their effective insolvency in 2008 and the associated bailouts, including 4.0% capital reserves, regular financial monitoring, examinations and risk assessments by the Federal Housing Finance Agency (FHFA), as dictated by HERA. Notably, an internal Treasury analysis in 2011 recommended capital requirements, consistent with the Basel III accords, of 3.0% to 4.0%. In addition, the President should name a substantial share of the boards of both enterprises, to act as public interest directors. The strategy has four basic elements to ensure that Fannie and Freddie can rebuild the capital required to responsibly carry out their basic missions, absorb losses from future housing downturns, and expand their efforts to support access to affordable housing for all households:
- In recognition of Fannie Mae and Freddie Mac’s repayments to the Treasury of $239 billion, some $50 billion more than they received in bailout payments, the Treasury would write off any remaining balance owed by the enterprises under the “Preferred Stock Purchase Agreements” (PSPAs).
- The Treasury also would end its quarterly claim or “sweep” of the profits earned by Fannie Mae and Freddie Mac, so their future retained earnings can be used to build their capital reserves.
- Fannie and Freddie also should raise roughly $100 billion in additional capital through several rounds of new common stock sales into the market.
- The Treasury should transfer its warrants for 79.9% of Fannie Mae and Freddie Mac’s current common shares to the HTF and the CMF, which could sell the shares in a series of secondary stock offerings and use the proceeds, estimated at $100 billion, to endow their efforts to expand access to affordable housing for even very low-income households.
Under this strategy, Fannie Mae and Freddie Mac could once again ensure the liquidity and stability of U.S. housing markets, under prudent financial constraints and less exposure to the risks of mortgage defaults. The strategy would dilute the common shares holdings of current private investors from 20% to 10%, while increasing their value as Fannie and Freddie restore and claim their profitability. Finally, the strategy would establish very substantial support through the HTF and CPM for state programs that increase access to affordable rental housing by very low-income American and affordable home ownership by low-to-moderate income households.
A valuation analysis of this recapitalization strategy confirmed that this strategy could deliver an additional $99.4 billion in warrant value for future affordable-housing programs. It also confirmed that Fannie Mae and Freddie Mac could achieve 4.0% capital reserves (Tier 1 capital) of some $180 billion through the combination of the public offerings of new common stock and their retained earnings from 2016 to 2020.
We also estimated the impact of this recapitalization strategy on the mission of the HTF and CMF to access by low-income households to affordable housing. Under HERA, the HTF and CMF are to be funded by Fannie Mae and Freddie Mac paying in 4.2 basis points (0.042%) of their new business, with 65% of the funds go to the HFT and 35% to the CMF. HERA also directs that no more than 10% of HTF’s funds can go for the administrative costs of the HFT and the state programs it supports. It further directs that 90% of the remaining funds(after administrative costs) go to support state programs for affordable rental housing for very low-income households, and 10% go to support state programs for homeownership by low-income households.
We compared the impact of our strategy on the activities of the HFT and CPM, using the $99.4 billion of warrant value for affordable housing, to the current requirements under HERA:
- Under our strategy, the HFT could provide $2.6 billion per year for state affordable rental housing programs, or $51.7 billion over 20 years, as compared to $196 million per year and $3.9 billion over 20 years under current arrangements. This would represent a 12-fold increase compared to current HTF support for state housing programs. (Table 1, below)
- Based on the average leverage ratio of current federal support for state housing programs, in which state public and private sources provide $4.86 for every $1 in federal funds, HTF support would produce $15.1 billion in additional spending for low-income rental housing per year under our strategy, compared to $1.1 billion under current arrangements. Taking account of this leverage, it represents a more than 14-fold increase.
- HTF support under our strategy should produce an additional 44,485 affordable rental units per year for very low-income households under our strategy, including 17,672 more units for African-American and Hispanic households, as compared to 3,471 additional units per year under current arrangements, including 1,379 for minority households.
- The 10% of HTF funds for state and local programs promoting homeownership by low-income households would increase such homeownership by 15,596 such households per year under our strategy, including 3,327 African-American and 2,359 Hispanic households per year. Under current arrangements, HFT funds increase low-income homeownership by roughly 1,217 households per year, including 260 African-American and 184 Hispanic households. This also represents a 12-fold increase compared to current HTF support.
Similarly, the reach of the CMF would be much greater under our recapitalization plan than under current arrangements.
- Under our strategy, the CMF could provide state grants totaling $1.74 billion per year, compared to $132 million per year under its current arrangements. This represents a more than 12-fold increase compared to current CMF state grants. (Table 2, below)
- Applying the estimated leverage ratio of 12:1 for community development non-profits, CMF support for their housing programs should produce 189,866 additional housing units per year for very low-income households under our plan, including 175,855 additional rental units and 14,010 additional owner-occupied homes. The CMF’s current funding should help produce 14,391 additional housing units per year, including 13,329 additional rental units and 1,062 owner-occupied housing for low-income households. Again, this represents an increase of more than 12-fold.
- Under the recapitalization plan, the housing projects supported by CMF funding would employ an additional 8,792 full-time construction workers and 152,272 seasonal construction workers per year, as compared to 666 full-time construction workers and 11,541 seasonal workers under the CMF’s current funding arrangements.
Seven years after the federal government rescued Fannie Mae and Freddie Mac and placed both companies into government conservatorship with majority government ownership, the two enterprises have generally recovered and, given the ability to build adequate capital reserves, they can now stand on their own. The recapitalization strategy outlined and analyzed in this study would restore their independent operations, and on terms which would expand U.S. mortgage markets. Under this recapitalization plan, Fannie Mae and Freddie Mac also should be able to withstand the next sharp downturn in U.S. housing markets. Finally, the plan provides the resources to vastly expand the stock of affordable housing for all Americans, including for those households with very-low or even extremely-low incomes.
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