When Will Government Control of Freddie Mac and Fannie Mae End? (Part 1)
Part 1: Why Government Control has Already Lasted 14 Years
Freddie Mac and Fannie Mae, the two government sponsored enterprises (GSEs) that have long funded roughly half of all single-family mortgages in America, were placed under government control on September 7, 2008, at the height of the financial crisis then underway. Under four presidential administrations, a handful of key policy decisions cumulatively extended that control far longer than anyone would have originally predicted; with its fourteenth anniversary approaching, moreover, there is arguably no end in sight. This article, the first of a two-part series, describes those decisions, as well as the background and thinking behind them. Part 2 will address why, even after 14 years, it will still take considerable additional years to end government control, and will describe what key actions can be taken now to begin the process of doing so.
The Bush Administration: Secretary Paulson and the Origin of Extended Government Control
The U.S. Government took control of the GSEs when the two companies, collectively then issuers of over $5 trillion of debt, were losing the confidence of the marketplace that those debts would be fully honored, threatening to spread and amplify the financial market collapse then already underway.1 To implement that takeover, the Federal Housing Finance Agency2 (FHFA), their regulator, used an obscure legal mechanism called “conservatorship3” whereby it was authorized to take total operating control of the organizations by legally stepping into the shoes normally occupied by both their shareholders and boards of directors.
While the FHFA then had legal authority to operate the GSEs, it did not have access to the government financial resources needed to restore market confidence in them. Rather, those resources come from taxpayers via the U.S. Treasury, led at that time by Henry Paulson. Secretary Paulson decided that the typical technique used by Treasury to help large banks restore deteriorated market confidence–equity injections4 to be paid back over time–was insufficient. Instead, he stated that “conservatorship was the only form5 in which I would commit taxpayer money to the GSEs.”6 Thus, alongside the conservatorship being established by the FHFA, the Treasury entered into a formal “Preferred Stock Purchase Agreement”77 (PSPA), by which Treasury would support the creditworthiness of the two companies. Paulson chose conservatorship because he believed that the fundamental operating model of the GSEs was defective, citing8 concerns such as “the inherent conflict in trying to serve both shareholders and a public mission,” that they “pose a systemic risk,” and “ambiguities in the GSE Congressional charters, which have been perceived to indicate government support” for them. He also said that policymakers “must view this next period as a ‘time out’ … while we decide their future role and structure,”9 and noted that only Congress could make the needed changes.
Some of the public interpreted Paulson’s use of the phrase “time out” to suggest a short punishment period. But this was very much a wrong conclusion. The conservatorship and the PSPA would continue, per Paulson, until structural changes were made through Congress, and as there was little consensus among its members about what those changes should be, they would likely not happen quickly. The PSPA, in fact, had an unusual feature that the monies invested by Treasury into the two GSEs were unable to be paid back (absent an appropriate amendment to that document to permit it). This signaled that the GSEs were never expected to go back to the status quo ante.
The Obama Administration: Its Policy of ‘Wind Down and Replace’ Fails
Just four and a half months later, the Obama administration took office. By that time, the political consensus about the GSEs had evolved past the general Paulson notion that some undefined structural changes were needed. As the companies were almost immediately requiring tens of billions of dollars of taxpayer investment through Treasury under the PSPA, they lost virtually all political support. While Republicans had longstanding mixed feelings about the GSEs,10 the strong historic support from Democratic officials quickly evaporated, and they became (in a phrase I heard frequently after becoming CEO of Freddie Mac in May 2012) “politically toxic.” Additionally, the two companies–and especially Fannie Mae–had been such aggressive lobbyists11 that there was a feeling of deserved comeuppance that added to the toxicity.
Consequently, a consensus in Washington soon arose that the GSEs should be entirely replaced with a yet-to-be-defined “something else,”12 which the Obama administration adopted as its own policy. And thus, for its entire eight years, the Obama administration GSE policy could be summarized as “wind down and replace.”13 But the administration also decided to not lead the effort to develop a replacement for the GSEs, but to defer to Congress to do so. For a topic of such complexity as the mortgage finance system, this deference to Congress almost guaranteed that the process would be slow.
In fact, Congress never developed that “something else,” either during the eight years of the Obama administration or since. The housing finance policy community–consisting of industry associations, DC-based think tanks across the political spectrum, academics and even various members of Congress–developed several proposals detailing what should replace the GSEs. These proposals (which uniformly reflected the ideological or economic interests of the proposer) ranged from a government-owned corporate monopoly, to a cooperative owned by the lending industry, to many small GSEs, to just relying upon the private market, among others. Some showed themselves to be fatally flawed very quickly, others only after more detailed examination. As far as I could tell, none came close to being broadly accepted to operate as promised, or to be effective. More importantly, none came close to Congressional approval.14
This failure extended the horizon of government control via the conservatorship. Also, the wind down policy turned out to be almost wholly rhetoric. The reality is that the GSEs were absolutely not wound down during the eight years of the Obama administration. Except for the major shrinkage of their discretionary investment portfolios,15 the Obama administration, along with the FHFA, routinely asked the two companies to do more, not less, in order to help families recover from the Great Recession. For example, the administration routinely asked Freddie Mac and Fannie Mae to help distressed families to stay in their homes, to help more people to own a home, to reduce taxpayer exposure to GSE risks by developing and implementing credit risk transfer transactions, and generally to meet much higher standards of safety and soundness than ever before.16 The companies, as a result, had to invest heavily in hiring and systems development–the very opposite of a “wind down.”
But the wind down policy did have a major impact in what became probably the most controversial GSE-related event during the Obama administration: the third amendment to the PSPA, about which there have been headlines and lawsuits ever since. As background, by mid-2012, the marketplace began to recognize that the structure of the PSPA might not, over time, have enough funding available to fully support the GSEs,17 in turn potentially leading to another loss of market confidence. To avoid this, the PSPA needed to be amended. The specific nature of the amendment that resulted (known as the third amendment) was, however, rather unusual: while it indeed eliminated the reasonable possibility of the available funding shrinking too much, it did so at the cost of guaranteeing that the two GSEs would run their capital18 down to virtually zero, regardless of what their earnings might be. I was told point blank by a Treasury official that this was done for consistency with the wind down policy of the administration.
Regardless, this meant that the GSEs, with virtually zero capital, would be wholly dependent upon the PSPA agreements to make them creditworthy issuers of their trillions of dollars of mortgage-backed securities (MBS). If the GSEs had in fact been wound down and replaced by other organizations, their having a de minimis level of capital might not have been a problem. But events transpired such that the GSEs had become even more important to the country’s housing finance system, not less–and the lack of capital extended by years any reasonable estimate of how long they would need to emerge from under government control.
Meanwhile, the GSEs in conservatorship had kept operating their core activities–the buying of mortgages and the issuing of their mortgage-backed securities–continued unabated the entire time, while at the same time taking actions to eliminate their fundamental flaws. Under FHFA direction, such actions included, for example, the GSEs massively reducing their discretionary investment portfolios and developing credit risk transfer (CRT) to reduce taxpayer’s exposure to GSE risks (and more broadly systemic risk).19 Because they were prohibited from lobbying by the terms of the conservatorship, their main focus became running quality commercial organizations such as they had never really done before, with much better customer service and technology.20 By the end of the Obama administration, then, with the failure to develop “something else,” many policymakers (and the mortgage industry, which generally found the GSEs to be commercially performing better than ever) began to focus on keeping the two much-reformed GSEs as being a viable option going forward. In other words, the “something else” that had long been sought would in fact be keeping the two GSEs but with all their reforms. Additionally, this alternative was usually based upon them being regulated like a “utility,” i.e., with pricing controlled by the FHFA.21
Thus, as of 2016-2017 (i.e., generally around the time when the Obama administration was in its last year), this “utility model” of the two reformed GSEs, as far as I could tell, became the most supported solution among policymakers (despite the official administration policy of “wind down and replace” being unchanged). It was by no means a consensus, but so far it is the only solution supported broadly and deemed truly workable–and with a low implementation risk to the economy and housing markets. Unfortunately, because of the third amendment, this meant the two GSEs would be starting their journey to the “utility model” with basically zero capital, i.e. to eventually escape conservatorship and operate as reformed companies, they would have to start raising virtually 100% of the required capital. While it is still unclear how much capital they would need to pursue this path, I would say that about $150 billion represents a reasonable estimate,22 and the requirement could potentially be even modestly lower. As discussed below, even this amount is so huge that it is likely to be raised mostly by retaining earnings over many years, rather than issuing new shares into the marketplace.
The Trump Administration: Both Shortening and Lengthening Actions
This was the state of affairs in early 2017 when the Trump administration took office and Steven Mnuchin became Treasury Secretary, coincidentally with a career background that included mortgages and mortgage securities. He stated, even before taking office, that dealing with the GSE conservatorships would be one of his top priorities. However, the Trump administration decided to largely defer any actions on GSE reform until the then-FHFA Director Mel Watt (a former Democratic Congressman23), ran out his five-year term24 and could be replaced by a Trump appointee, which was not until a full two years into the four-year term of the administration. This critical loss of time basically undermined the desire by Mnuchin to make progress on the GSEs exiting conservatorship (with or without any additional reforms he might want) as there would be so little time left to pursue it. After Watt’s term ended in January 2019, the administration appointed Mark Calabria, a long-time critic of government intervention in the mortgage markets generally and of the two GSEs specifically, as the new FHFA Director. Calabria was confirmed and took office in April 2019.
In September, just months later, Treasury produced a “Housing Reform Plan”25 that included a very long list of recommendations. While officially issued by Treasury, the reality is that it had to represent the entire administration, including the input of the FHFA which, as the regulator and conservator of the GSEs, had a large say in shaping the administration’s policy. In fact, I found that there were two camps inside the administration in terms of GSE views: the pragmatists, associated with Mnuchin, who wanted to improve the housing finance system but not jeopardize the ready availability of the 30-year fixed rate mortgage or risk disruption while implementing changes; and the GSE critics, associated with Calabria, who wanted to aggressively reduce the size of the two GSEs (known as “shrinking their footprint”), if not outright eliminate them altogether. As such, the list of recommendations in the reform plan document were very inconsistent and ran the gamut from some well-accepted and practical ideas to a wish-list of others that had little support outside of GSE-critical think tanks.
Unfortunately, with just 16 months left in the Trump administration’s term, the long list of recommendations overwhelmingly went nowhere. But there were a few key recommendations that were actually implemented, although also reflecting the inconsistency of the plan. Most important, in my view, were three:
- Starting in September, 2019, the GSEs–by joint agreement of Treasury and FHFA, as expressed through an amendment to the PSPAs–were, for the first time since the third amendment of 2012, to retain their earnings to build capital in significant amounts.26 Such capital building is a key requirement for the GSEs to enter the off-ramp to end conservatorship, and it remains in place today.27 In my view, it was the most impactful GSE-related decision made by the Trump administration. This impact of this policy is to hasten the end of government control.
- The FHFA also developed and promulgated a new minimum required capital rule for the GSEs, finally establishing how much capital the two companies would need to have as a pre-condition of exiting conservatorship. The capital requirement was unfortunately set at a level that was broadly considered extremely high28 (a viewpoint with which I agree); such a result was unsurprisingly consistent with FHFA Director Calabria’s desire to reduce their footprints.29 That need for a larger capital raise translates directly into lengthening the period of government control.
- Even worse, the new capital rule included a perverse incentive that discouraged the use of CRT transactions, despite Treasury’s desire for a robust and effective CRT program.30 As a result, Fannie Mae (but not Freddie Mac) actually ceased such transactions for over a year, which has had the incremental impact of increasing the amount of capital31 needed–and the time to raise it–to exit conservatorship.
Thus, the Trump administration–including the FHFA under Calabria–was simultaneously enacting policies that both shortened and lengthened the time required to exit conservatorship.
Another action by Mnuchin was to disclose that the administration would consider taking a path toward ending conservatorship without Congress enacting legislation, an approach that had been developed during the Watt years as director of the FHFA, and kept almost totally confidential to avoid a negative Congressional reaction. This alternative path was known as “by administrative means”32 and it would implement GSE reform solely through a collection of amendments to the PSPA as well as regulations issued by the FHFA. While Mnuchin indicated he would prefer that Congress enact legislation, there was no pushback from Congress on his proceeding administratively to get started. Thus, the development and adoption of an administrative path removed a major impediment to GSE reform actually commencing.
Between dwindling days in office and other priorities, the Trump administration did not pursue any additional significant steps on the path to ending government control.33
The Biden Administration: Will There Be More Than Benign Neglect?
It is now one and a half years into the Biden administration. So far, there has been no evident focus within Treasury or the White House on GSE reform or exiting conservatorship; instead, the very visible focus of the administration is to implement programs to make housing more affordable and eliminate racial disparities. However, with Republican-appointed Calabria continuing his five-year term (ending April 2024) as Director of the FHFA, it was clear that he, as conservator, would not be particularly aligned with these priorities and thus take little, if any, actions to support them in his directives to the GSEs. It was therefore fortuitous for the Biden administration that the Supreme Court ruled in June 2021 that the FHFA would no longer be an independent agency (for technical reasons related to its structure), allowing the President to fire Calabria and replace him with someone more supportive of its agenda. In the meantime, he appointed as the acting FHFA Director Sandra Thompson, its top civil servant; President Biden later nominated her as the permanent Director, and she has since been confirmed.
So far, the directorship of Thompson is known, in my view, for two core policy directions. First, pursuing the mission of the GSEs-including various Biden administration initiatives–but absolutely consistent with safety and soundness,34in which she has a strong background having previously worked at the FDIC for over two decades. And second, she has begun to publicly talk about taking actions to prepare the GSEs for eventual exit from conservatorship, even while the administration is not currently prioritizing such an exit.35
Recapping Part 1
Upon the two GSEs being placed into conservatorship in 2008, few expected that Freddie Mac and Fannie Mae would be able to exit conservatorship quickly and go back to the status quo ante. Yet there was also no expectation that government control would be so enduring, with its 14th anniversary in just two months and no end in sight. Instead, the length of government control was repeatedly extended as a byproduct of specific decisions made by all three presidential administrations involved. The one major exception was the Trump administration allowing the GSEs to retain their earnings in order to build capital, one of the major steps needed to put them onto the off-ramp to exit conservatorship. The question at this time is what to expect going forward: (1) the government continuing its current level of control for the foreseeable future, despite earnings being retained; or (2) getting the two GSEs fully onto the path to being reprivatized again, albeit while retaining the reforms made to them during conservatorship. That will be the subject of Part 2.
 With over $5 trillion of debt outstanding at that time, the losses to investors that a failure of confidence in the two GSEs’ ability to service their debts would incur was so large that those losses would have additionally weakened the already-unstable markets, creating an even greater financial crisis than actually took place.
 Not only was the marketplace losing confidence in the two companies, but Congress had already lost confidence in their previous regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), and in July 2008 replaced it with the FHFA as a newly created successor.
 Conservatorship is one alternative by which regulators of banking and similar institutions can deal with an imminent failure situation. Other common alternatives are receivership, arranging a sale to a stronger organization prior to an actual failure, and (in collaboration with Treasury) injecting equity into the institution.
 Such equity injections also usually included various “penalty” aspects, e.g. limits on executive compensation and dividends.
 Another option available would have been receivership, but that could imply that GSEs might be put into run-off, making no more mortgages, precipitating another blow to the value of homes that were already then declining rapidly. That would have been totally contrary to the purpose of the rescue of the two companies.
 See Secretary Paulson’s September 7, 2008 statement when the GSEs were placed into conservatorship. https://money.cnn.com/2008/09/07/news/economy/paulsonstatement/index.htm.
 The PSPA is structured as a “net worth keep-well” agreement, by which Treasury agreed to inject equity (in the form of buying senior preferred shares) into the two GSEs as needed to make sure the net worth of each never went below zero.
 Secretary Paulson’s September 7, 2008 statement.
 Secretary Paulson’s September 7, 2008 statement.
 On one hand, they ideologically opposed such major government intervention into what otherwise may have been provided by the private market. On the other, they supported homeownership. The net impact was that Republican presidential administrations, as a generalization, tepidly accepted the GSE system.
 One member of Congress at that time referred to Fannie Mae, in a private discussion, as “such a bully.”
 “GSE reform” became the name for developing replacement proposals at that time.
 For example, see the Treasury press release, dated February 11, 2011, “Obama Administration Plan Provides Path Forward for Reforming America’s Housing Finance Market, Winding down Fannie Mae and Freddie Mac.” https://home.treasury.gov/news/press-releases/tg1059.
 The most well-regarded proposal, the bipartisan Corker-Warner bill, was based upon the “many small GSEs” concept which looked credible when examined at a high level. Under more scrutiny, it became clear it would not work as promised. It failed to make it past a positive Senate committee vote in 2014. Every proposal had specific reasons that prevented them from being workable, but in my view the two most common were: (1) there was no obvious way to transition from today’s system to the proposed new one without undue risk that mortgage markets would be disrupted, and thus drive down home values and impair household finances; and (2) the inability to raise, on competitive terms, the astoundingly large amount of capital which would be required to be even a modest-market share competitor.
 These portfolios exploited a loophole in the structure of the government support to the GSEs, had been widely criticized for many years, and have since been reduced with little impact on the core operations of the two companies. Their wind down was a requirement of the PSPAs established prior to the Obama administration taking office.
 These higher standards applied to all large financial institutions in the wake of systemic weaknesses the financial crisis revealed.
 The PSPA was structured such that, if the GSEs did not make enough profit each quarter to pay a required 10% per annum coupon on the senior preferred stock outstanding (that quarterly payment was about $4.5 B, or almost $18 B per year, by 2013), they had to take down more funding under the PSPA to make the full payment. This then reduced the remaining amount of the Treasury’s promise to support the companies, and eventually the unused amount would have declined enough that the marketplace for GSE debt would not have seen it as being large enough to make good on its going-forward support of the two companies.
 Their capital level going into 2012 was near zero, as routine quarterly losses from the Great Recession had only recently been ending. The net worth of each had begun to grow into 2012 but was only several billion dollars each by the time of the Third Amendment mid-year.
 The list of all such actions was very long. To give a further flavor of their nature, three of them were: (1) securitizing and disposing of non-performing loans and, separately, modified loans; (2) developing and implementing more rigorous financial and operating requirements on non-bank seller/servicers; and (3) developing and implementing a completely new regime under which sellers were obligated to repurchase loans that had previously been sold to the GSEs but which proved to have defective documentation.
 I have often noted the conundrum of this result: when the GSEs were owned by public shareholders, they were not quality commercial organizations, although excellent lobbyists and influencers in Washington to retain and expand subsidies; when they were under the conservatorship of the FHFA, they became de-politicized and quality commercial operators.
 I have found most policymakers look at the regulation of electric utilities as a guide when this going-forward GSE model is discussed. That type of price regulation was happening at that point inside conservatorship, with little transparency to the public however.
 This estimate comes from work I have done in research concerning the government-mandated annual stress test results. I will publish an article concerning those tests that shows the development of this number shortly after the latest stress test results are made public, which is scheduled for August.
 Director Watt was a Congressman for over two decades and was known for being very liberal. However, his term as FHFA Director was noted for being generally very mainstream.
 At that time, the FHFA had independence from the administration, and thus its Senate-confirmed directors could not be fired by the administration, except for cause. As mentioned below, in June of 2021, the Supreme Court eliminated that independence, allowing a Presidential administration to fire them for any reason at any time.
 U.S. Department of the Treasury. (2019). Housing Reform Plan: Pursuant to the Presidential Memorandum Issued March 27, 2019. https://home.treasury.gov/system/files/136/Treasury-Housing-Finance-Reform-Plan.pdf.
 There had been a small revision earlier, under Director Mel Watt, to allow Freddie Mac and Fannie Mae each to build up $3 billion of net worth. This was designed to ensure that routine quarter-to-quarter earnings volatility (including at times just due to certain accounting rules) did not cause there to be a need for Treasury to inject more equity into them.
 As of March 31, 2022, the combined net worth of the two GSEs have grown from near-zero to $83.5 billion. On average, market conditions had been quite favorable to the GSEs, and thus their profits higher than usual, since they had been allowed to retain earnings starting in September 2019.
 As part of the rulemaking process, the FHFA is required to give an opportunity for public comment on its proposals. The vast majority of those comments considered that the approach taken in the proposal generated too high a capital requirement.
 Earlier, Director Mel Watt had proposed a more mainstream capital rule, but it was never completed during his term. The Calabria capital rule built upon it but added many buffers and other changes that significantly increased the total.
 A careful reading of the Housing Reform Plan shows an inconsistent view about CRT. This reflected, apparently, that Treasury was supportive while Calabria was not.
 In financial institution regulation, capital (which consists mostly of common equity) is required to absorb potential losses. As CRT transactions transferred to investors the obligation to absorb a portion of the loss that would otherwise hit the P&Ls of the GSEs, it reduced the capital they required.
 In contrast to “by legislative means.”
 FHFA Director Calabria, who was independent from the administration, made many comments in speeches and media outlets that such steps were in the works and imminent. However, none were implemented prior to the end of Calabria’s tenure as FHFA director.
 “Safety and soundness” is a standard financial institution regulatory phrase. In colloquial terms, it means that in response to some market or other stress, the institution will be highly resistant to collapse.
 Many preparation steps can be implemented solely by the FHFA. Others would require Treasury involvement.