After his successful Valentine’s Day hearing at the
Senate Banking Committee, it looks like Mark Calabria is on his way to becoming
director of the Federal Housing Finance Agency (FHFA). In that capacity, he
will oversee more than $6 trillion in mortgage-related assets—in very round
numbers, more than $3 trillion for Fannie Mae, $2 trillion for Freddie Mac and
$1 trillion for the combined Federal Home Loan Banks.

For the $5 trillion of Fannie and Freddie, the
FHFA director is more than a regulator. He is the conservator, who has the
combined powers of CEO, board of directors and regulator, for as long as Fannie
and Freddie are in conservatorship. As is well-known, but seems unbelievable,
that has been more than 10 years so far, for a supposedly temporary status. When
might it end?

Mr. Calabria rightly told the senators that the
fundamental design of housing finance must be determined by Congress. But it
doesn’t require Congress to end the conservatorship and the intertwined bailout
deal (the Senior Preferred Stock Purchase Agreements) with the U.S. Treasury
Department. That could be done by the FHFA and Treasury, working together, just
as they did to implement the conservatorship and bailout agreements in the
first place.

Should they do that?  Only if Fannie and Freddie get serious, much
higher capital requirements as an essential part of the arrangement. That is
the first of four key requirements. As the American
reported: “Calabria said he supported the GSEs [Fannie and Freddie]
having significantly more capital.” The absolutely right position. The report
continues, “but he added that the FHFA director cannot unilaterally require an
increase in the capital reserves under the current terms of the preferred stock
purchase agreements.” Also right—it takes agreement with the Treasury, which on
behalf of the taxpayers, currently takes all the risk of Fannie and Freddie.

How much more capital should Fannie and Freddie be
required to have?  A lot more. Using them
to escalate the leverage and the risk of the giant housing finance system
should be eliminated. For details, see “Changes
to capital rules should be part of GSE overhaul

In addition to capital, there are three other
requirements if Fannie and Freddie are to be successfully taken out of

  1. They need to pay a meaningful fee to the
    Treasury for the government credit support they will continue to have, since
    they are and will continue to be Far Too Big To Fail (not just TBTF, but
    FTBTF!). This fee should be at the same rate the Federal Deposit Insurance
    Corp. would charge a bank of equivalent riskiness for government deposit
    insurance, for which the Treasury is also on the hook.
  2. Their enormous systemic risk must be regulated,
    in addition to their micro risks. This means they should be formally designated
    as the systemically important financial institutions (SIFIs) they so obviously
    are. This can be done administratively by the FSOC (Financial Stability
    Oversight Council), which is chaired by the secretary of the Treasury.
  3. Finally, the Treasury should exercise the
    warrants it holds to acquire, at a fraction of a cent per share, 79.9 percent
    of the common stock of Fannie and Freddie. This is part of the return to the
    taxpayers, through the Treasury, for having first saved Fannie and Freddie and
    then made their continuing existence possible. They could not exist even for a
    minute without Treasury’s credit support.

Could a sounder and better Fannie and Freddie
emerge without legislation?  Yup.

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