Tim Pagliara on the steps to recapitalize Fannie Mae and Freddie Mac

Tim Pagliara on the steps to recapitalize Fannie Mae and Freddie Mac
Image source: Fannie Mae

ValueWalk’s Raul Panganiban interviews Tim Pagliara, Founder, Chairman and CIO of CapWealth group and Grant Stark, CFA, director of research at CapWealth Group. In this part, Tim and Grant discuss the steps to recapitalize Fannie Mae and Freddie Mac, and if the upcoming election cycle will impact the urgency for it.

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Raul Panganiban: Yeah. And what are those steps that they can be doing to recapitalize Fannie Mae and Freddie MacFannie Mae and Freddie Mac?

Tim Pagliara: Well, I think that the, you know, the first thing that they they need to do is settle the underlying litigation and declare the senior preferred paid with interest. Right now there's an excess of the the, Fannie Mae and Freddie Mac that paid in excess of $30 billion over and above what they owe the government and 10% interest. That $30 billion can be put on the balance sheet, as a special periodic commitment fee as an asset that the government will hold for their role in during that the mortgage market continues. And and then they need to get them. You know, they need to get them out of conservatorship.

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And to do that, and settling the litigation, the preferred stock, which has a face value of approximately $33 billion. Those shareholders can take a haircut, they can take 10 to 15%, less than, than face value, and then all of a sudden, you've got an additional $25 billion, you know, of capital that goes into these entities. So these entities can exit conservatorship under a consent decree with the instructions to raise additional capital to the private sector that will make the common stock of Fannie Mae and Freddie Mac go up and the government remember owns 80% of the common stock of Fannie and Freddie.

So all of a sudden they're making an additional 50 to one hundred billion dollars off of the investment that they've made and Fannie and Freddie over the last 12 years, that money can then be used as a source of relief for the American homeowner for the American economy, at the same time that you're attracting private capital back into this into the system.

And all of that can be done very quickly. It will provide the Federal Reserve with some additional relief because Fannie Mae and Freddie Mac they have the expertise to buy back and evaluate and appropriately build their portfolio and increase the size of their portfolio. They'll have capital that they don't have right now. And, again, this is going to be critical for the recovery part of what we're going through.

They will will have the ability once they get relisted on the New York Stock Exchange once they are fully functioning with with their board of directors, they will have the ability to go out and attract private capital and build capital reserves going forward, which is what they should have done anyway, we are very late to the party if this had been done in 2012. We would already have these fully functioning entities, you know, with adequate capital and we would be dealing with it you know, the average FICO score in Fannie Mae right now it's about 750. Again, this is not a credit problem.

It is not like 2008. It's a liquidity problem we get we need to get mortgage rates down. We need to allow the American family to recapitalize to redo their balance sheet to reduce their monthly payments and To create additional liquidity to help through the crisis.

Grant Stark: And I would just add to you know, it's I would say, back, you could look back all the way to 2010 2011 timeframe, there has been demand for participation, that probably, you know, private private market demand. It has not waned. You know, investors understand that these are these are essential businesses, these are strong companies, all they need is to be well capitalised. And that is something in the near term that the Federal Housing Finance Agency, which is the regulator, the conservator is, is already well on their way to to finalising, in fact, they're going to put out some some standards in a month or two that that will be under review.

And so the idea is, you know, we're starting the conversation that should have happened years ago, but better, better now than ever, and it's it's a perfect opportunity for the government to take a win. and generate some liquidity that's much needed in the mortgage market. Because if you know if Bob from Iowa goes to his local bank to get a mortgage, and it's at 3.75%, when every other interest rates at zero, that's going to confuse him, right?

It doesn't it doesn't make sense. And there's there's not a reason for that, other than there's a fundamentally fundamental break in how the system is supposed to operate. And the beauty is, the gses have the size and scale to be able to fix that plumbing problem and provide liquidity. But they just need to have that faucet turned on. And they did so in 2008. That actually wasn't quite the issue. They helped the market through that if you look at total MBs issuance volumes, so the amount of these mortgages that were being packaged and sold it went from about a 50% market share between Fannie Mae and Freddie Mac that they were issuing to almost 100% overnight and That's because they were the they were the only entity that could step up because everybody else ran scared.

And that's what's happening today. And that's what still can be prevented. But that's, you know, that gets me back to my original comment or the comment on, you know, this, this wasn't a human caused issue like 2008 was, in fact, it's the opposite. And we can also now have, we have the tools to make sure that we can get through a smoother and we know how to do that now.

Tim Pagliara: To add to Grant's point to that, you know, that we have these solutions, you know, the discussion, this was just a threshold moment, to force us to make the decision that should have been made a while back. And when you look at, again, Fannie Mae and Freddie Mac, you know that their mission is to maintain liquidity in the mortgage market. That means that at times like this, they're not going to make as much money as they would during good Remember that guaranteed fee that they have is, you know, and don't quote me like an analyst on this, but it is somewhere around $30 billion a year in pre tax earnings. And so that money comes in is cycled through the mortgage market, we need to use that money right now we need to take the profitability of these entities in their book of business and put them towards the mission that they were intended for.

And, and this is, you know, this is why, you know, everybody needs to act. Now we've we've had that solution in place, you know, and no one is better qualified to deal with this than director Calabria and Secretary Mnuchin. They have, you know, tremendous experience in in the functioning of the mortgage market, the knowledge of the mortgage market, how these entities are structured. And, and so, this is something that could be done in 60 to 90 days or less. All they have to do is make the calls and put this in place.

They have a financial adviser, Houlihan Lokey that can run the interference and advise them on the particulars of how to get this executed through the financial markets. I know that the boards have both Fannie Mae and Freddie Mac, they would, you know, they are chomping at the bit to go back to work on behalf of the American people. And it's the right thing to do at this point. And unfortunately, it's gone on too long. The only thing that would be worse than allowing this to go 12 years without a solution is to not grab the solution. That's right in front of us now.

Grant Stark: Yeah. Yeah. And I would I would say to highlight the importance of that point is, you know, we have we have senators and lead Slater's flying in on overnight flights, costing taxpayers hundreds of thousands of dollars, to get to a vote for a $2 trillion package to bridge liquidity in other markets, they're essentially burning the midnight oil trying to hurry up. And, you know, let's build a package. Let's get this this this package together.

The difference here is that every every mind, every financial mind, every every facet from the government to private markets, has thought about what is the most efficient solution and has sort of, you know, gone back and forth for almost a decade now on what makes the most sense, and refined to this point, right. And so to Tim's point is, this is not something that that is coming up based on a response to the issue. This is this is actually the opposite where we can respond to the issue based on what we've already been planning for for the last five to 10 years.

And so I think that's, that's Very helpful because there's no there's no sense of urgency as far as planning, right things. I mean, they couldn't have hired Houlihan Lokey and we couldn't have gone through all of the steps on looking at what are the proper capital levels within two weeks, like you could maybe do to send a check to everybody for $1,000. Right. This is a, this is a much more nuanced market. But the beauty of it is the works already been done. We just can't we just have to hit the button.

Tim Pagliara: I'm going to be contacting my senator, my representatives, I would hope individuals that that that understand this issue, you know, and and recognise the need to lower mortgage rates, increase liquidity in the mortgage market, I would encourage them to do the same. You know, everybody has an opportunity to contribute. I watched this morning as one of the suppliers for Major League Baseball They were you know, they make uniforms in the end and, and hats and memorabilia.

And in the middle of the night, the founder of the company, he got up, and he had an idea. He's making masks and protective gear now out of, you know, what was baseball equipment, this is a time for everybody to come together and move the needle forward. It's a time for solutions. It's a time for people to think and act in responsible ways. And there's nothing more responsible right now than to get this settled and move it forward on behalf of the American people.

Raul Panganiban: Definitely. And does the upcoming election cycle. Does that have any play into this and the urgency for it?

Tim Pagliara: No. And I would hope that the last thing anybody would want to do is politicise the needs of the American people to have some relief on interest rates, on their mortgages and the refinance needs that they have, and the need to continue to buy homes. I mean, the world is stopped, but the needs of the world have stopped.

You know, I've talked to builders that have had, but they've cancelled, you know, closings on homes because rates went up and people are concerned, you know, people need, you know, they need some incentives to go out and get their lives back to normal. And the best thing they can do this, we're going to start this economy back up in how fast this economy starts back up, depends upon some of the things that we do to facilitate it. That's what you know, I think Treasury Secretary, former Treasury Secretary Bernanke, he said you know, in his talk, you know, there is a V scenario which is the optimistic scenario.

There's a U scenario. And then there's a scenario that if we don't act extends this economic downturn, you know, much longer. And we don't want that. Yeah, you know, we want to, we want to minimise the impact of this virus on the American people. And this is one of the ways we can do it.

Grant Stark: And if you look back, you know, in history, if you look back in history, if you certainly go back to 2006, the gses were probably the most politicised entities in the US if not in the world. And and they were by no means a bipartisan organisation. But the just back to my earlier point on being able to refine and debate the what what the best outcome is, for the American people over, you know, the last five years has enabled all the stakeholders, including the government, which as Tim mentioned, owns, you know, 79.9% of the common law Exercise there, they're a stakeholder as well.

And so there is a win win solution where it's sort of it'd be the solution becomes agnostic to the party because there's an obvious need forFannie Mae and Freddie Mac. I've talked about that in the past that these are these are essential businesses. And this is part of our plumbing.

I mean, heck, they make up a little almost 30% of the bond in market with with MBS. And, and it's, you know, if you put these if you put these two entities on the books, it would dramatically increase the, the outstanding debt. So I think everybody gets that these are critical.

They're, they're critical for liquidity. They're critical for every American for wealth, and it's certainly a way that underserved and and low income individuals can also have an opportunity to build wealth and start a family and housing is still very much a part of that in the US. So, you know, I think it's a little bit agnostic who's coming in and the the outcome is becoming ever more clear that they are one necessary in two, there is a path forward that works for both sides of the aisle.

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Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)www.valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver
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