There has been a lot of recent activity regarding the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac swirling around and reported only in bits and pieces.  Most is linked in some respect to the so-called "net worth sweeps" in which the profits of the two GSE's, less a diminishing buffer reserve must be paid to the U.S. Treasury each quarter in the form of a dividend.  This requirement was put in place in August 2012 as an amendment to the original Senior Preferred Stock Agreement (SPSA) between Treasury, the Federal Housing Finance Agency (FHFA), and the GSEs which required only a specified dividend.

The Legal Issues

First, several lawsuits filed by stockholders challenging the sweeps are still working their way through the courts. The plaintiffs are largely hedge funds who bought into the company after their downfall at fire sale prices,  Most suits are struggling through appeals of earlier decisions favoring FHFA, their conservator since they were seized by the government in 2008, effectively ruling that FHFA can do whatever it pleases with their two charges. One suit critical to this discussion is Collins v FHFA.

In recent months, another issue has arisen in these suits that does not directly involve the powers vested in FHFA as conservator.  Here we must digress to a separate lawsuit, PHH Corporation v CFPB, in which the constitutionality of the Consumer Financial Protection Agency is in question.  While the two agencies were set up under separate legislation, FHFA under the Housing and Economic Recovery Act of 2008 and CFPB by the Dodd Frank Wall Street Reform and Consumer Protection Act, they have similar structures, a single director (not the multi-member commissions common to many independent federal agencies) who serves a specified term of office and cannot be removed without cause.

The DC District Court found for PHH on the constitutionality issue.  While CFPB has been granted a rehearing of that finding, the Department of Justice (DOJ) has refused to defend its petition and has filed an amicus brief on the part of PHH.

On October 20 2016, Plaintiffs in the Collins case filed a fourth count in their complaint charging that having an FHFA single director who could not be fired "at will" was unconstitutional. This, they contend, would make any agreement - i.e. the SPSA and therefore the sweeps - invalid.  On February 9 plaintiff requested a summary judgement on that count.

Two weeks later FHFA filed a motion opposing the request along with support from the U.S. Treasury supporting their opposition, aka Footnote 1. That footnote reads, "Treasury also joins in FHFA's request that the court dismiss Plaintiffs' separation-of-powers claim (Count IV) for the reasons provided in FHFA's Opposition to Plaintiffs' Motion for Summary Judgement."

On March 17, in DOJ filed the amicus brief in favor of PHH referenced above.

It now appears that DOJ is preparing to take a similar stand in Collins.  On March 24, Chad R Readler, Acting Assistant Attorney general sent the following message to that court.  "In light of the United States amicus brief in PHH Corporation v CFPB, to the extent it may be necessary in this case to reach the issue of whether the removal provision applicable to FHFA's Director is constitutional, Treasury does not urge reliance on Footnote 1 of its reply memorandum."  In other words, we didn't support CFPB's constitutionality and are probably now reviewing Treasury's support of FHFA.

Financial Reform

A second undercurrent in the GSE soap opera is the near-decade long debate over how to reform the housing finance system in the U.S., a debate which may ultimately hinge on what happens to Freddie and Fannie on any of the fronts were discussion.  However to some extent this is resolving itself mainly through inertia as FHFA slowly institutes the agenda set forth in its strategic plan for the GSEs.  Both the single security proposed for the two and the Common Securitization Platform have recently taken steps toward full operation.


The third issue, and the one most germane at the moment, is the GSE's recapitalization.  While time is short, there is now some speculation that the sweep of their fourth quarter 2016 profits scheduled for payment before the end of March, may not take place.

One of the avowed goals of the 2012 amendment was to prevent the GSEs from recapitalizing. The net-worth sweep leaves them with a buffer reserve, but that buffer steadily diminishes and will reach zero after the fourth quarter of this year. This has worried many housing advocates. In the face of even a mild reprise of the 2008 housing crisis, the two would have no financial resources and would have no option but to resume their draws on the U.S. Treasury - something they have not done since late 2011.

It appears that reversing the net-worth-sweep is solely within the power of the Director of FHFA, Melvin Watts, and the Treasury secretary.  Watts, who was not involved in setting up the requirement, has been in favor of allowing the GSEs to recapitalize, voicing concerns over the risks of stripping their reserves, but deferred to former Treasury Secretary Lew on the matter.

The new administration is considered generally friendly to recapitalizing, possibly even releasing the GSEs from conservatorship. The new Secretary of the Treasury, Steven Mnuchin has made favorable statements to that effect, enough that there has been renewed trading activity in the common and preferred stocks of the two companies which, since the GSEs have not been placed in receivership, still have speculative value.

In January, Bloomberg's Elizabeth Dexheimer reported that, after his formal confirmation hearing, Mnuchin updated his comments. Most of his responses had to do with the Volker rule, but Dexheimer says he also weighed in on the finance reform issue.  In response to a request from Senator Sherrod Brown (D-OH) Bottom of Form

to provide additional details on a housing-finance plan that could protect taxpayers as well as expand mortgage access, Mnuchin wrote that "any solution will be dependent upon the GSEs being capitalized properly and other such controls that eliminate risk to taxpayers."

The stakes for Mnuchin and Watts got a little higher last week.  A letter was sent to both, signed by eight organizations, including Community Home Lenders Association, Community Mortgage Lenders of America, The Leadership Conference on Civil and Human Rights (which itself is said to have 200 organizational members) NAACP, and the National Community Reinvestment Coalition (NCRC).  It expressed concern about the GSEs' declining capital buffer and asked FHFA to suspend the upcoming dividend.

All of this indicates that the long, drawn-out Freddie/Fannie drama may be winding down. We don't have a clue as to what the outcome will be; even less do we know which issue will finally trigger it.