By Joseph Pigg
With Republican control of the administration and both chambers of Congress taking effect in January, there has been much speculation about what may happen with Fannie Mae, Freddie Mac and the Federal Home Loan Banks, as well as with their regulator, the Federal Housing Finance Agency.
One thing seems certain based upon the approach taken by the first Trump administration: independent agency heads that serve “at the pleasure of the president,” like FHFA Director Sandra Thompson, will be asked to resign on or very shortly after the inauguration and pending regulatory actions will be put on hold. Because it may take months for a new director to be confirmed, some might expect a long period of stasis.
There is, however, speculation among market and political observers that change could occur very quickly at FHFA, given the role the agency may play in high profile Administration priorities. Extension of the 2017 individual income tax cuts (and potential other tax changes) will be a top priority for the new administration and Congress. Congress is expected to use a parliamentary procedure called budget reconciliation (which permits simple majority votes in both houses and thus cannot be filibustered) to effectuate those changes. Because reconciliation is primarily a budgeting process, it generally requires offsets for any spending, or explicit authorization for deficit-financed programs not otherwise offset by spending — such as a potential continuation or even expansion of tax cuts. One potential offset reportedly being considered is the recapitalization and release from conservatorship of Fannie Mae and Freddie Mac. While much will depend on the arcane rules around reconciliation and “scoring” of the cost or savings of proposals, depending on how the process is structured, ending the conservatorship of Fannie and Freddie could generate significant savings to offset the cost of tax cuts.
Using recap and release for budget reconciliation presents both opportunity and risk. One opportunity is that it shifts the focus of FHFA back to Fannie Mae and Freddie Mac and away from the misguided efforts of recent years to “reform” the Federal Home Loan Bank system — which is not broken or in need of reform. It also rekindles interest in ending the conservatorship of Fannie and Freddie, which has gone on since 2008 and is long overdue. The ongoing conservatorship amounts to de facto nationalization of our mortgage finance system. It is not only bad policy, but it will eventually prove unsustainable as it subjects the GSEs to politicization and puts taxpayers directly on the hook for any losses.
Risks arise, however, in the execution of recap and release. While an initial reconciliation bill is expected to happen early in the second Trump administration, the process for ending the conservatorships will be complex and may take years. Reconciliation only locks in target dates and a mandate for the administration to carry out the plans. Details regarding the recap and release will be tremendously important —– including the level of capital that will be required of the GSEs post-conservatorship, the degree of oversight and regulation that will be left to FHFA, and the degree to which — if at all — Congress enacts key reforms that would prevent the GSEs from veering into dangerous territory and repeating past mistakes(or finding new ones to make).
There are also risks for the Federal Home Loan Banks. Even if FHFA backs away from the misguided efforts of the current administration to change the mission and focus of the FHLBs (something it lacks the authority to do), risks arise in that any changes to the status of Fannie and Freddie will also impact the FHLBs. As an example, an explicit federal guarantee backing Fannie and Freddie could put the FHLBs (which carry an implied but not explicit guarantee) at a disadvantage among investors.
Much will likely become clearer in the near term with yet-to-be-announced changes in leadership at Treasury and FHFA, and release of plans for tax reform and any recap and release proposals. But the real work to get the details right — and to prevent unintended consequences — will just be beginning.
