How Do You Solve a Problem Like Fannie and Freddie?

(Bloomberg Businessweek) -- As the director of the U.S. Federal Housing Finance Agency, Mark Calabria has a relatively low-profile job. He’s the designated watchdog for a small group of financial institutions, most notably the mortgage giants Fannie Mae and Freddie Mac, which have been under government control since the financial crisis. But as the Trump administration moves to take both companies out of conservatorship, Calabria is for the moment one of Wall Street’s most powerful and closely watched regulators.

Billions of dollars in hedge fund bets—and the fate of a $5 trillion market in mortgage bonds—could hinge on the decisions Calabria makes in the coming months. So could the availability of affordable 30-year mortgages, which Fannie and Freddie help make possible by buying up home loans and packaging them to be sold in the bond market. By May or June of next year, he says, Fannie or Freddie may be ready to exit U.S. control and seek an infusion of cash from new investors in what could be one of the largest public stock offerings ever.

Fannie and Freddie are two of the strangest creatures in finance. U.S. taxpayers rescued the companies from failure in 2008 with a $191 billion bailout. Since then, they’ve been required to send the bulk of their profits to the government, but their shares have continued to trade. Investors who snapped those up after the collapse could get a windfall if Fannie and Freddie become fully private again. On the other hand, investors in mortgage-backed securities worry about the government stepping away from Fannie and Freddie and giving no assurance that it will back those bonds in the event of another crisis.

Calabria insists that he’s tuning this out. “The law says I have to get Fannie and Freddie out of conservatorship; it does not say ‘unless some hedge funds benefit,’ ” he says. “There’s nothing that says, ‘You shall exit unless Wall Street doesn’t want you to.’ That is not a relevant consideration.”

Since he took the helm of the FHFA last year, Calabria, who was previously Vice President Mike Pence’s chief economist, has spent a lot of time on the road reassuring people he’s not going to blow up what amounts to 15% of the U.S. economy. Allies and foes agree that Calabria, who’s spent most of his career in Washington, is skilled at knowing just what to say to pacify the concerns of lawmakers, lobbyists, and housing advocates. But almost a year after he became head of the agency, he still hasn’t answered some of the thorniest questions about what comes next, and he’s fallen behind on some of his own deadlines.

“If you want things to be durable and stick after you leave, it takes time,” says Calabria in an interview during a visit to the National Association of Home Builders annual trade show in January. The conference is in Las Vegas, and this year a big draw is a private tour of a 6,400-square-foot luxury home overlooking the city’s skyline, complete with infinity pool, walk-in wine cooler, and custom fire pit. As Calabria strolls past the motorized screens that line the mansion’s windows, he reflects on how 12 years ago Nevada was a hot spot of the foreclosure crisis that triggered the worst recession in a generation and forced Fannie and Freddie to the brink.

“My job is to make sure they don’t fail again in the next downturn,” Calabria says.

Even so, Calabria’s skeptics worry that the lessons of the crash will be forgotten in a rush to reprivatize. “I’ve still got a lot of concerns,” says Senator Mark Warner, a Democrat from Virginia who’s been part of several failed efforts to get Congress to pass a housing reform bill. “At the talking stage, I’ve found he’s got a lot more openness to some of our ideas. But I want to make sure that whatever reform takes place doesn’t end up with the same duopoly with no constraints that got us into this crisis in the first place.”

Calabria has several big tasks ahead. One is writing a rule dictating how much capital Fannie and Freddie will need to avoid ever needing another bailout. As recently as 2017, there was still a risk the U.S. Department of the Treasury would have to shoulder the companies’ quarterly losses. If Fannie and Freddie have to retain more capital, they might have to buy fewer loans or back away from riskier ones, which could raise mortgage rates or make types of some loans less available. Last year, Calabria said the capital rule would be announced in the first quarter of 2020. In Vegas, he says, “It could slip a little bit, but it will be soon.”

Also on Calabria’s to-do list is ending the Treasury Department’s sweep of Fannie’s and Freddie’s profits, which is required under the 2008 bailout agreement. In September, Calabria and Secretary of the Treasury Steven Mnuchin took a key step by raising the amount of profits the companies can keep before sending the rest to the Treasury Department. Calabria says within the next year he hopes to negotiate more substantial changes to the bailout terms.

It’s these potential changes that get to the heart of what hedge fund titans such as Pershing Square Capital Management’s Bill Ackman and Paulson & Co.’s John Paulson have for years been waiting for. Shareholders in Fannie and Freddie have gone a decade without a dividend. The end of conservatorship could increase the value of the shares and, depending on the deal that’s hashed out, result in a substantial payday for some hedge funds. Calabria says the treatment of shareholders will ultimately be decided by the Treasury Department. “I haven’t seen a term sheet yet from Treasury; we’re still negotiating,” he says. Calabria has consistently said that shareholders should have been wiped out when the companies were bailed out in 2008.

Still, money managers with Fannie and Freddie stakes have friends in all the right places in Washington. Paulson is a big fundraiser for President Trump. Mnuchin invested in Paulson’s hedge fund before joining the Trump administration. Mnuchin also served on the board of Sears Holdings Corp. with Bruce Berkowitz, whose firm Fairholme Capital Management is also a shareholder in Fannie and Freddie. A spokesman for Paulson declined to comment, and a spokesman for Fairholme did not return calls for comment. A Treasury official said the agency’s preference is to work with Congress and it hasn’t considered any specific proposals for recapitalizing the companies.

Also lobbying hard are bond investors, banks, and asset managers. Groups such as the Securities Industry and Financial Markets Association are trying to convince Calabria and the Trump administration that releasing Fannie and Freddie without an explicit guarantee of their bonds could make investors wary about buying them, which in turn would increase funding costs and mortgage rates. An explicit guarantee is something only Congress can provide, though Mnuchin has said that even if Congress doesn’t act, the Treasury Department will continue to provide some supports. Calabria insists he’d have to sign off on that as well, and says that while he’s willing to proceed without it, no decisions have yet been made.

There are lots of things that could throw Calabria’s plan off track—for starters, Trump not getting reelected. Democrats have generally been leery of taking the duo out of conservatorship, worrying that as private companies they wouldn’t be able to ensure housing affordability. A turn in the U.S. housing market is also a risk, and a long slide in the U.S. stock market could also complicate any plans for the companies to attract new equity investors. Calabria is “clearly learning the realities of the job and how hard this is,” says Mortgage Bankers Association lobbyist Bill Killmer. “There’s a reason why it has taken so long to fix Fannie and Freddie.”
 
Michael Bloomberg, founder and majority owner of Bloomberg LP, Bloomberg Businessweek’s parent, is one of several candidates seeking the Democratic presidential nomination.

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net

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