DS News

81 81 INVESTMENT GOVERNMENT PROPERTY PRESERVATION Bill of 2014 which called for competing "mini- GSEs," but it never came close to becoming law. Public examination of the bill brought up serious concerns about the proposal which ranged from fatal flaws to a general consensus that the bill was unworkable in practice. Around 2018, policy experts and mortgage industry players shifted away from revolution and moved towards evolution keeping the GSEs operations as normal to avoid disruption to the complex mortgage markets. us "comprehensive GSE reform" has now become "GSE reform" meaning the companies will be reformed rather than replaced. If anything, the GSEs have thrived under conservatorship. Many of the reforms instituted in the last 14 years have helped them along including: limiting investment portfolio size limits, shedding risk via credit risk transfer transactions, and the requirement of a robust and much higher capital requirement. "is evolutionary approach to GSE reform thus called for keeping all the changes made during conservatorship," Layton said. "It also called for regulation akin to how states regulate electric and other utilities (which includes setting prices charged to the public). Today, this utility-style GSE reform is the only major idea still around with broad support. Interestingly though, it did not emanate from any of the sources of earlier big and bold proposals, but out of the careful, years-long work of reforming the GSEs inside conservatorship by the FHFA, with Treasury also playing an important role." Legislative vs. administrative paths to GSE reform: Where do they stand? Ideas for reform obviously require new legislation to be passed, but when it became clear that there was a shift from replacing GSEs to reforming them through what became known as an "administrative path." Layton said that this approach bypasses the need for congressional legislation because the changes necessary for the GSEs to exit this oversight could be made by the FHFA through regulation, plus the Treasury could modify the existing contract by which the enterprises gets funding through them. "Right now, in fact, the consensus in Washington is that any legislation about GSE reform will not happen for many years at a minimum," Layton said. "Given how well the GSEs are working in conservatorship, there is no pressure on Republicans or Democrats in Congress—who have very different ideas about what should be done with the GSEs— to force compromise on a reform plan. at means the administrative path is the only realistic option available right now." What two key GSE reform activities are quietly underway right now? According to Layton, the most important GSE reform activity now underway is that the two enterprises are retaining all their earnings to build capital, an extremely important fact that many people gloss over. is makes the GSEs more financially stable, meaning they do not have to ask the treasury for additional cash injections, which are ultimately funded by taxpayers. e second reform activity FHFA Acting Director Sandra L. ompson is making changes to Calabria-era regulatory minimum capital requirements which called for an "unnecessarily high level" of capital. e limited scope of the revisions that have been implemented are designed to eliminate a "perverse incentive" for the GSEs to take on high risk mortgages and an equally perverse disincentive to lay off mortgage credit risk. "Unfortunately, those are the only two important GSE reform activities underway right now," Layton concluded. What should we watch for to see if additional GSE reform activities get underway? Layton sees three areas where additional government action is needed to facilitate a conservatorship exit. ese changes are major undertakings which will take a lot time to implement (Layton estimates years, not months). ey are: » The existing regulatory minimum capital rule must be revised downward. is means largely adopting the underlying economics of how capital is required for risk in the banking system, but then applying it to the particulars of the GSEs, which are very much not banks, where the current capital rule treats them too much as though they are. Too high a regulatory capital requirement would directly translate into a privatized GSE having too high a cost of capital. As the largest component of guarantee fee pricing is the cost of capital, that would directly lead to inordinately high guarantee fee pricing by the two companies. Such a revised capital requirement would take at least a year, maybe even closer to two, to develop and implement. » The FHFA must build the proper legal and operational infrastructure for utility-style regulation of the GSEs after they would have exited conservatorship. is is a heavy lift for the agency, assuming it duplicates the well-established state- level utility regulatory regime rather than trying to create something de novo. is would include establishing wholly new activities such as holding public hearings when the GSEs request pricing changes, examining all operating expenses to see which ones might be ineligible (e.g. unduly lavish customer entertainment), doing financial and economic studies to determine the required rate of return for investors (about which hearings would also be held), and so on. ese things are second nature to state-level public utility commissions, but far afield from what financial regulators like the FHFA do. » Ultra-complex mechanics need to be developed and implemented for each GSE to restructure the ownership of its equity. at ownership is currently distorted by Treasury holding all of the senior preferred stock (with over $200 billion outstanding) as well as warrants on 79.9% of the common stock, both of which sit beside the historic (i.e. pre- conservatorship) common and junior preferred shares, which are still owned by public market investors. (Such public market investors have few rights during conservatorship, but its ending would return those rights—such as the ability to elect the Board of Directors—to them.) A conservatorship exit requires that this equity ownership structure become undistorted and conventional, and free from conservatorship-related legal uncertainties. Treasury, more than the FHFA, is key to this happening, and the complexity, especially in such immense size and for two companies at the same time, is unprecedented. (Included in this undertaking would be establishing a fee for the GSEs to overtly pay Treasury for its support.) Journal

• Cover