Sunday, October 21, 2018

I disagree with Don Layton, the GSEs were innovative..when permitted

Are they or aren’t the the GSEs government?

CBO says “Yes”; OMB/Treasury say “No”

It would take people with time and an inclination to listen and  absorb--meaning few in Congress—to explore why some of the confusing and conflicting treatment the GSE’s get in Washington adds to the public’s befuddlement over  what Fannie and Freddie do, what they are, and what are their true worth to the nation’s mortgage finance system.

I wrote about some of this in my last blog, but then—in the interim—this Congressional Budget Office (CBO) document appeared. I thought it conveyed--better than I had--what causes some of the GSE muddle in DC.

Those clashing government agency descriptions add to the Fannie and Freddie doubts, aids those wish to distort GSE values or even status, and adds to a situation which lends itself to manipulation and mortgage market distortion by GSE political and business entities.

Are they part of the government or aren’t they, are they on the US Budget or aren’t they? As noted in this CBO discussion, it depends on who you ask??

In the meantime, the two financial behemoths chug along--from their secondary mortgage market perch—and deeply support the US primary mortgage market, where consumers first go to get mortgage loans (based on underwriting conditions Fannie and Freddie set) on any loans (which are most!) lenders send to the GSEs to be securitized, i.e. put into mortgage bonds or mortgage backed securities (MBS) for which--for a fee--the two then guarantee payments to securities investors. (That GSE  bond sales action recycles  proceeds to lenders for future loan making.)

Maloni’s historical perspective. The Congressional Budget Office (CBO) always had the GSEs in its “green eyeshade” accounting/policy crosshairs, even when Democrats ran the institution, but CBO’s pronouncements were--and still are--largely ignored except to score rhetoric points.

The flip side is Treasury and OMB often institutionally merged at the hip for GSE policy and political reasons.

To wit, the two Cabinet players still refuse to admit--following the GSEs forced “conservatorship” in 2008 and their management's/board's operational surrender to the federal government--Fannie and Freddie became “federal agencies,” because it could mean the GSEs combined $5 Trillion in assets and liabilities would have to appear on the official federal budget.

That would be a no-no for any Admin, but especially the current one, which—because of the $3 Trillion deficit it’s added in DJT’s first two years in office and projected eight more years of similar red ink-- even it has a public relation point it refuses to go beyond.

Ergo, no way will Mnuchin’s future GSE actions put the GSEs on the federal budget.

Don Layton, National Journal Article & American Banker Interview

“The GSEs were not a source of innovation for decades, if ever. Now we are a source of innovation," Layton said, adding that he hopes the legacy of his time at Freddie Mac will be that he helped make the GSEs more competitive with each other. (Layton interview in National Mortgage News.)

I don’t know Don Layton, Freddie Mac’s outgoing President, who plans to retire within a year.

I read two articles headlined above, done around the time of last week’s MBA Washington DC convention, and it left me rather cold, still trying to understand what was his message about his six years heading Freddie and what his hopes are for the future secondary mortgage market system.

Let me first establish my biases.

Based on my personal history as a former Fannie executive and my later years when I just observe the national mortgage markets and interplay of the GSEs, I’ve never been overly impressed with the Freddie management team and believed they were more nascent and less innovative than Fannie.

Worse, they also seemed very comfortable being both those things, as the second party in a GSE dominated system, each business day, automatically, Freddie would get sufficient product—seldom a majority—but enough to keep them happy.

Freddie execs were comfortable with Fannie getting a bigger market share and taking most of the market and political risks. It became part of the institution's chemistry and affected each of their Presidents, decent people but hardly creative business giants.

I assumed Fannie and Freddie still compete against one another for mortgage loans, but Fannie always has been the larger of the two, so I guess “which shop gets the most business” isn’t a Freddie imperative and seldom was in the past, because they just weren’t that nimble or price sensitive.

Time is money, the Fannie MBS, the Freddie PC, and other things

While Freddie was the first to securitize mortgage in the early 1980’s, the company stuck with its more clumsy and slower paying bond model, after Fannie came out with its more efficient and attractive to lenders and institutional investors mortgage backed securities (MBS), because Fannie distributed  payments faster to invinvestors from the underlying loans.

Once Fannie’s MBS roared past Freddie’s in term of liquidity (more of it out there) and better pricing, the superior/inferior die was cast. Despite a Freddie PC dink here and there, Freddie was forced to settle in second place and accepted it in perpetuity.

For years Freddie stuck with its market clumsy (in comparison) “participation certificate” or PC, which never matched the more efficient and better paying Fannie mortgage-backed security or MBS. 

That is the main reason Freddie has been so supportive and jubilant about the new GSE common security, which both will employ in the future. It will bring better pricing to Freddie at Fannie’s disadvantage. 

When Treasury and the FHFA forced the GSEs to develop a common securitization platform,  Freddie cheered and yelled ”onward,” while Fannie quietly nodded “go ahead,” but dragged its feet because it was being forced to give up its long held advantage.

Back to Mr. Layton, his interview, and his quotes below. (Layton in American Banker interview.)

“Competitiveness is built into our DNA—I just have to keep it going. We’re starting to think a little bit about the down cycle. It’s been a great run up. I don’t think there’s going to be a strong down cycle, but we have to be prepared for it.
“Whatever we can do to help to land [the proposed rule on enterprise capital] and bring that to finality is important to us. We’re an expert on that, we care about it a lot and we developed the kind of father to the system that eventually came out. The comment period ends the middle of next month. The finalization of it should tie in … with my retirement.”

For an entity with “competiveness built into our DNA,” Freddie has been very sleepy.

If they are such experts, I certainly hope Freddie will NOT toady and endorse FHFA’s capital proposals with capital levels geometrically higher than what is needed for a secondary mortgage market entity which only securitizes lender produced mortgages with strong underwriting standards?

Sorry Mr. Layton, even in your time Freddie has been more about making FHFA and the Treasury happy than breaking down doors and responding to competitive challenges.

Mr. Layton, I wish you future good luck and much success.

If/when you enter the GSE dialog as a civilian, come in wearing your big boy pads. I hope you are a far more aggressive activist and GSE advocate than you’ve been as Freddie President.

Maloni, 10-22-2018

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