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Calabria’s GSE Reform Could Trigger A Recession: Dick Bove

Debate over removing Fannie Mae and Freddie Mac from conservatorship continues as the two government-sponsored enterprises reported healthy Q4 earnings results. The two GSEs reported their earnings results the same day Trump’s choice for the next director of the Federal Housing Finance Agency (FHFA) was set to testify before the Senate.

30-year fixed rate mortgage
geralt / Pixabay

It seems likely Congress will approve Mark Calabria as the next FHFA director, but one well-known bank analyst is warning against it. Richard Bove thinks Calabria would be good for Fannie Mae shareholders but bad for housing values.

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Q4 hedge fund letters, conference, scoops etc

Calabria before the Senate

Bove has been writing about Fannie and Freddie for some time now. Earlier this week in a note for Odeon, Bove offered a preview of Calabria's Senate appearance, which was scheduled for Thursday. He emphasized that the next FHFA director will decide when and how the two GSEs leave conservatorship. As a result, it's important to understand Calabria's views on GSE reform before he's appointed to or even nominated for the office.

In previous writings, Calabria had suggested that he would seek payment for preferred shareholders of Fannie and Freddie but probably wouldn't seek anything for common shareholders. His previous writings also suggested he would require the GSEs to recapitalize as traditional banks and try to reduce all government subsidies for residential mortgages.

This last point could have a serious negative impact on the 30-year mortgage, and Bove warned that if the government did pull back on its "implicit guarantee of 30-year fixed rate mortgages," then 30-year terms would disappear, housing prices would plunge, and a recession may result. Bove said he had been assured that Calabria had changed his views on 30-year mortgages, and others have reported the same elsewhere.

When he did appear before the Senate on Thursday, Calabria did update his views. According to the Financial Times, he said he thinks the Trump administration may be able to recapitalize Fannie and Freddie without support from Congress. However, he also said that Congress would need to enact more meaningful GSE reforms like injecting new competition into the mortgage market.

He also said the FHFA should work toward getting the GSEs "on a stable footing for the next downturn when it inevitably comes."

"A true libertarian"

Bove and others have made particular note of Calabria's libertarian views and how they relate to his thoughts on GSE reform. Bove describes Trump's FHFA director pick as "a true libertarian," and after his Senate appearance, he said Calabria "now advocates positions that if put in place would create billions in profits to the shareholders of Fannie Mae and Freddie Mac." He then went on to explain three key pieces of the puzzle when it comes to deciding whether or not to own shares of the two GSEs.

The first is Calabria himself. Bove feels he knows more about housing finance and related legislation than "any other U.S. citizen." He has also emphasized on multiple occasions that the government shouldn't be involved in the housing finance markets. He has also called for Fannie and Freddie to be abolished and argued that the FHA and Federal Home Loan Banks put taxpayers at risk and distort housing prices and values.

However, Bove adds that more recently, Calabria has moderated his positions by "suggesting that the Treasury Department and the FHFA violated public trust by removing the dividends due to Fannie Mae and Freddie Mac shareholders." He now calls for turning the two GSEs into traditional banking organizations with no government support. Additionally, he still sees the mortgage securitization model as a threat to the financial system and believes banks should originate and hold mortgages in their portfolios.

The FHFA and 30-year mortgage

One of the other two pieces Bove described is the FHFA itself, which was established by the Housing and Economic Recovery Act in 2008 to guide Fannie and Freddie back to solvency. However, he also said that the powers granted to the director of the FHFA "are so widespread" that the U.S. courts are questioning whether they are constitutional.

The FHFA director has no one to report to, and neither the president nor Congress can question his actions without passing new legislation. In other words, whoever takes the helm of the government agency would have the power to do pretty much whatever he thinks would be best.

The third piece of the puzzle is the 30-year fixed rate mortgage. Bove said since the Great Depression, multiple bills regarding housing finance have been steadily reducing the monthly costs of home ownership by extending the duration of home loans and steadily increased the need for government subsidies to support these long-term mortgages.

He explained that if the 30-year mortgage should disappear, "monthly costs for owning homes would rise and the prices of every house in the United States would decline." He also warned that it probably would "at the very least, put the United States into a recession or perhaps even worse."

What will GSE reform look like with Calabria at the FHFA helm?

Bove then explains what he believes Calabria will do if he is allowed to take the helm of the FHFA. He expects Calabria to restore Fannie's and Freddie's dividends to shareholders while privatizing them, which "would create a windfall profit for the United States government and the private sector holders of Fannie and Freddie preferred stocks." If Bove is right about this, then many well-known hedge fund managers would benefit, like Gator, which argued the case for Fannie's preferred shares in a recent letter to investors.

However, on the other hand, Bove also expects Calabria to eliminate the government subsidies, essentially wiping out the 30-year fixed rate mortgage in the process, potentially triggering a recession.

"He is a very high risk potential nominee much more so than whoever becomes the new Chief of Staff in the White House," Bove concluded.

This article first appeared on ValueWalk Premium