Kroll Rating Agency Frames GSE Reform Around Urban Myths
January 27, 2017 at 1:00 pm,
4 comments
Every credit analysis must grapple with two eternal questions: How do the past and present inform us about the future? And, what is the breakeven? Kroll Bond Rating Agency all but ignored the first question in its report, “Housing Reform 2017: Can the GSEs be Privatized?" It simply failed to consider how Fannie Mae and Freddie Mac had been self-supporting for more than 35 years, right up until the day they were apprehended by the government. "KBRA reminds all concerned with the issue of housing finance reform that the GSEs failed because of a loss of confidence and market liquidity, not inadequate capital,” it says.
Really? If the metric for GSE failure is a loss of market liquidity, then the tangible evidence against the GSEs seems to be non-existent.
The GSEs access the short and medium-term debt markets once a week, on Wednesdays. “Fannie and Freddie Debt Funding Smooth,” was the Reuters headline on the morning of September 3, 2008, the last Wednesday before the government took them over. Later that day, Reuters reported that, "the two government-sponsored enterprises continue to have relatively unhindered access to debt funding." That same day, the Associated Press reported, "The companies' ability to sell debt has diminished expectations that a government rescue is imminent. Investors are demanding a smaller premium for Freddie Mac's debt than last month."
One reason why Fannie and Freddie maintained unfettered access to the unsecured debt markets was their highly liquid balance sheets. The GSEs reminded investors in every quarterly financial report that they were required to maintain 90-days liquidity at all times. Fannie's July 2008 Monthly Summary Report, released in mid-August 2008, showed the company held $103 billion in liquid investments.
Investors could also access Fannie’s 2008 Funding Summary Reports, which disclosed how the company funded itself each month. Fannie issued more short-term debt than it repaid in every month, except for the three months, which had four, instead of five, Wednesdays.
Market confidence also came from Treasury Secretary Hank Paulson's testimony before the Senate Banking Committee on July 15, 2008. “Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies,” he testified. Paulson sought legislation, the Housing Economic Recovery Act of 2008, which gave the Treasury Department temporary emergency powers to invest in GSE securities at terms accepted by the GSEs. Any Treasury investment would be done for the purpose of, among other things, “The need to maintain the corporation’s status as a private shareholder-owned company.”
Kroll Ratings is right about GSEs' regulatory capital, which was more than adequate on the date of the government takeover. Fannie had bolstered its capital by issuing $7.4 billion in new common and preferred shares in May and June 2008.
Given that the companies had adequate liquidity and adequate capital, plus Treasury’s vote of confidence, investors were dumbfounded to learn that the government intended to wipe out the value of shares issued four months before the September 2008 takeover.
"The Treasury Department's decision to wipe out shareholders of two of the largest financial institutions on the planet shocked markets, making it apparent that no institution was safe," writes Mark Zandi of Moody's Analytics in his book, Paying the Price.
British economist Anatole Kaletsky agrees. In Capitalism 4.0 he writes. “Paulson’s decision to wipe out the Fannie and Freddie shareholders just a few weeks after their official regulator had issued a public declaration of their solvency, and at a time when they were still enjoying positive cash flows, sent a terrifying but unmistakable signal to shareholders in all other U.S. banks and financial institutions: They, too, could be wiped out by a U.S. government fiat at a moment’s notice, even if the banks they owned were generating positive cash flows, had raised new capital, and had received regulatory approvals as recently as a few weeks before.”
“The government's takeover of Fannie and Freddie arguably ignited the global financial panic," writes Zandi. That panic triggered liquidity crises at Lehman Brothers, AIG, Morgan Stanley and other firms, which held large risk exposures to deeply subordinated tranches of private label residential mortgage-backed securitizations. (By way of contrast, the GSEs held only the most senior triple-A tranches of RMBS deals.)
Securities firms can require enormous amounts of liquidity in order to trade on behalf of their clients and themselves. If clients pull their accounts, or if banks cut their daylight overdraft lines, a firm’s operations can come to a sudden halt. Whereas the GSEs’ largest business segment entailed unfunded guarantees of mortgage securitizations; and it never funded itself with demand deposits or uncommitted lines.
We must be careful not to conflate Wall Street’s liquidity crises with the issues faced by the GSEs. Indeed, there seems to be no hard data showing that the GSEs’s “implicit guarantee” from the federal government, which had been in effect for decades, was not working successfully right up until the date of the government takeovers. Which is why the notion, posited by KBRA and others, that recapitalized GSEs might not continue their operations absent an express federal guarantee, seems to be based on urban myths instead of hard data.
4 comments - Kroll Rating Agency Frames GSE Reform Around Urban Myths
Rob Zimmer - January 27, 2017 at 5:30 pm
The two companies will function as Hera utilities going forward, with some tweaks executed by statute or by the regulator. There's no vote count in Congress for scrambled eggs "reform" handing it all to the big banks, nor for severing the gses from their existing charters under Hera and prior Acts.
anonymous - January 27, 2017 at 6:12 pm
Davis,
There is a need to create a "wall of shame rating" for the entities and the people who use false narratives to create these myths, and perpetuate fraud on public to enrich themselves.
And also there is a need to create "wall of shame repository of articles" as a reference for current and future generations.
There is a need to create a "wall of shame rating" for the entities and the people who use false narratives to create these myths, and perpetuate fraud on public to enrich themselves.
And also there is a need to create "wall of shame repository of articles" as a reference for current and future generations.
David Fiderer - January 28, 2017 at 11:16 am
rc whalen
Thanks. I'm not quite sure what to make of your that salad, which seems a propos to not much. What does Brandeis's decision in Benedict v. Ratner--a 1925 Supreme Court case about the formalities necessary for a pledge of receivables--have to do with the piece written above? I don't see what it has to do with the GSEs' 35-year history of self-sustaining profitability, or with the GSEs' robust liquidity at the time of the government takeover. And I don't see what it has to do with the GSE charters enacted by Congress.
You say: "At the end of the day, the private investors are victims of fraud -- perpetrated by the US Congress! They are not shareholders but rather creditors." It might be the first time ever that shareholders of a company in conservatorship had their status elevated to that of creditors.
Whatever, "Fed officials since LBJ have assured their counterparts around the world," the facts remain that neither the GSE conservatorship nor the government's initial investment in the GSEs were necessitated by insolvency or illiquidity.
No one else, to my knowledge, has ever claimed that, "the USG never really relinquished control over the GSEs." Nor has the government claimed that it nationalized the two companies, despite its actions to that effect.
Thanks. I'm not quite sure what to make of your that salad, which seems a propos to not much. What does Brandeis's decision in Benedict v. Ratner--a 1925 Supreme Court case about the formalities necessary for a pledge of receivables--have to do with the piece written above? I don't see what it has to do with the GSEs' 35-year history of self-sustaining profitability, or with the GSEs' robust liquidity at the time of the government takeover. And I don't see what it has to do with the GSE charters enacted by Congress.
You say: "At the end of the day, the private investors are victims of fraud -- perpetrated by the US Congress! They are not shareholders but rather creditors." It might be the first time ever that shareholders of a company in conservatorship had their status elevated to that of creditors.
Whatever, "Fed officials since LBJ have assured their counterparts around the world," the facts remain that neither the GSE conservatorship nor the government's initial investment in the GSEs were necessitated by insolvency or illiquidity.
No one else, to my knowledge, has ever claimed that, "the USG never really relinquished control over the GSEs." Nor has the government claimed that it nationalized the two companies, despite its actions to that effect.
Best,
Chris