Rumors that the outgoing Trump administration would spring an 11th hour effort to privatize Fannie Mae and Freddie Mac were set to rest when the government-sponsored enterprises’ overseers reached an agreement to limit their growth—but without major structural changes.
The agreement between the Federal Housing Finance Agency and the Treasury Department includes such elements as: a permanent ceiling on the agencies’ multifamily lending volume; locking in requirements to focus on affordable housing; enabling them to retain much more of their profits; and an obligation to comply with rules that require them to set aside more regulatory capital.
Taken together, these provisions put Fannie and Freddie on a path toward ending conservatorship by strengthening their long-term financial position. Although it could diminish their dominance of the multifamily lending market somewhat, the new rules fall short of the all-out effort to privatize the agencies that was rumored to be in the works.
“The amendment will allow FHFA Director Mark Calabria to move the GSEs slightly closer to a conservatorship exit, (but) it doesn’t open the door to ending conservatorship without buy-in from the Biden administration or new legislation from Congress,” said David McCarthy, senior director of government and policy relations at the CRE Finance Council, a Washington, D.C.-based trade group.
Running Out the Clock
The Trump administration, particularly FHFA Director Mark Calabria, set ambitious goals to release the GSEs from conservatorship, where they have been since being bailed out by the federal government in 2008. After he was appointed to a five-year term in 2019, Calabria ended the cash sweep that sent Fannie’s and Freddie’s profits to the federal treasury, the first step toward financial stability and setting them free.
The change in administration set off a regulatory clock for Fannie and Freddie. Not only will the newly appointed Treasury Secretary Janet Yellen probably have a different perspective on the GSEs, but the new president could try to dismiss Calabria immediately. It remains unclear whether that is Biden’s intention, but the president’s power to fire an agency head without cause is the subject of a case before the Supreme Court.
That left Calabria and former Treasury Secretary Steve Mnuchin to walk a tightrope between negotiating an agreement that would help achieve their goals of privatization and reducing the market footprint of the GSEs without roiling the real estate lending industry, which has been operating without much trouble in recent years. Industry housing trade groups including the Mortgage Bankers Association sent a letter to Mnuchin last month urging him to not push the agencies out of conservatorship before they had enough capital.
In the end, it was impossible to raise the capital needed to release the GSEs from conservatorship in the time before the new administration took charge. Thus the agency heads opted for incremental change that puts Fannie and Freddie on the path to privatization, but which can’t be achieved without the support of a future administration.
Weaker Competitive Position
The new agreement does put some limits on Fannie and Freddie that leaves more room for competitors. The most obvious limits are an $80 billion annual cap and the requirement that at least half of originations are on properties that meet a threshold of affordability. The FHFA has set annual caps in the past; for 2021 it is $70 billion, following an $80 billion limit in 2020.
The new cap is permanent, although it could be changed through an agreement between Yellen and the FHFA director. That gives Calabria some control if he can stay on as FHFA director through the end of his term, a possibility which depends on the outcome of the lawsuit before the Supreme Court.
Another element of the agreement is that enables the GSEs to retain capital beyond the previously agreed-to level of $45 billion ($25 billion for Fannie and $20 billion for Freddie). To date, Fannie has accumulated about $21 billion and Freddie $14 billion, according to CREFC. Now, however, the agencies can retain earnings up to a combined $280 billion, which is what the FHFA estimated was the necessary level for privatization.
For more than a decade after conservatorship began in 2008, Fannie and Freddie were required to sweep profits into the federal coffers. The GSEs’ preferred stockholders, which own about $31 billion of preferred stock that has not received a dividend since 2008, remain embroiled in a lawsuit that contends the cash sweep agreement was illegal. The Supreme Court is expected to rule on the case during its current term, which ends in June.
Another element of the new agreement is that it binds the GSEs to the capital framework adopted by the FHFA in 2020. The rule requires the GSEs to maintain tier 1 capital of 4 percent of assets, which amounts an increase in the amount of regulatory capital the GSEs must hold. That serves to make them safer from losses but also increases their cost of capital.
These and other parts of the new agreement, taken together, put Fannie and Freddie on the road to better financial health while slightly reducing their competitive position in the multifamily market. The GSEs’ chief advantage has been their low cost of capital, which enables them to beat competitors on loan rates. That advantage is diminished somewhat by the higher capital threshold. Meanwhile, Fannie and Freddie are also constrained by origination limits and the requirement that half of their business must encompass properties that meet the test of affordability.
Permanent reform has been discussed for years, and the commercial mortgage industry would prefer a permanent framework for the GSEs, but agreement has been impossible. No solution has a consensus among policymakers and the lack of an imminent problem in the mortgage markets has made it less of a political priority.
As such, the new agreement is being well-received by most of the industry. Lenders such as commercial banks, insurance companies and CMBS programs would all like a better competitive position relative to the GSEs so they can originate more loans on apartments. The utility of the agency model, however, was demonstrated in 2020 during the pandemic, when Fannie and Freddie remained active as most lenders stopped writing new business because of COVID-19.
Rob Van Raaphorst, vice president of communications at MBA, said the new agreement “preserves and extends a level playing field for lenders of all sizes and business models while avoiding near-term measures that could have threatened market stability … It is critically important that measures to guide the GSEs’ market footprint carefully balance the need for them to meet their affordable housing mission for both single-family and multifamily homes.”
To some, the action was mostly about optics since most of the changes can be reversed when new appointees gain oversight powers. “The only thing going on is that earnings can continue to be retained,” said one long-time industry insider. “The rest is about optics and politics and actually is unlikely to last very long.”