Treasury, FHFA Reverse ‘Net Worth Sweep” at Fannie and Freddie

The headlines yesterday were that the Trump administration had failed to exit Fannie Mae and Freddie Mac from the government-owned conservatorship. This is true and disappointing, but overlooked in many media accounts is that the Treasury Department and the Federal Housing Finance Agency (FHFA) did hammer out an agreement that will help protect taxpayers, Fannie and Freddie’s private shareholders, and the housing market at large. It is also an important first step toward privatization and exit out of the conservatorship. And for various reasons, it will be difficult for the Biden administration to reverse this action.

The amendments to the Preferred Stock Purchase Agreements (PSPA), in which the government took control  of 79.9 percent of the shares of Fannie and Freddie, replace the Third Amendment of 2012 and effectively ends the government’s “net worth sweep” of Fannie and Freddie’s profits. This a positive step for taxpayers, shareholders, and the housing economy as whole.

As I wrote in recent comments to the FHFA:

The “Third Amendment” to the GSE’s conservatorship, promulgated by the Obama administration FHFA and Treasury Department in 2012, abrogated [the Housing and Economic Recovery Act’s] mandate and imposed costs on taxpayers, the housing market, and ordinary investors. The Third Amendment allowed the Treasury Department to siphon off 100 percent of the GSEs’ profits in perpetuity. In turn, the government began ‘sweeping’ virtually all of the GSEs’ profits—well exceeding the cost of the 2008 rescue—into its coffers, leaving the GSEs with very little capital.

This arbitrary government action posed a risk to taxpayers of being on the hook for another bailout should there be any volatility in the housing market. It also deterred competitors, such as banks, which faced their own increasingly rigid capital requirements from laws like Dodd-Frank, from getting into the secondary market of buying and selling mortgages, thus reducing beneficial innovation and liquidity in the mortgage market.

In addition to its harms to taxpayers, the Third Amendment net worth sweep abrogates the contractual rights of Fannie’s and Freddie’s private shareholders. As Richard Epstein, eminent property rights expert and law professor at New York University, said at a recent CEI event, “There’s a breach of every known sense of fiduciary duty dating back to Roman times and consistency followed through in an effort to make sure that self-dealing by the government would wipe out these shareholders.”

The new amendments to the PSPA effectively end the net worth sweep until Fannie and Freddie have raised the capital to the specific levels required under the 2020 regulatory capital framework. It will likely be difficult for the Biden administration to change this in the immediate future.

Amending these amendments requires the agreement of both the Treasury Department and the FHFA. The FHFA will be controlled by Mark Calabria until the end of his term in April 2024, unless the Supreme Court rules in Collins v. Mnuchin that the president has the right to remove him. Even if the administration of incoming President Biden does get the opportunity to reverse the amendments, one would hope it would refrain from doing so for the sake of taxpayers, shareholders, and the housing market.