Should the GSEs be privatized? with Jim Millstein, Jim Parrott, Mark Zandi
Willy Walker: Good afternoon and welcome to another Walker Webcast. I am absolutely thrilled to have my three friends, Jim Millstein, Jim Parrott, and Mark Zandi, join me today for a conversation on a topic that is, I guess, very timely and top of mind for many people, as it relates to the potential privatization of Fannie Mae and Freddie Mac after 17 years in conservatorship. Hard to believe it has been that long. I'm sure this conversation will go back to the moment when they were taken into conservatorship in 2008. As we start, what I'd love to do is just have each of my guests do a quick intro of themselves, including where they sit today and why Fannie and Freddie are on their radar screen. I can't think of three people who know more about the topic that we are going to discuss today. If there are, there are very few, and what we're looking to do is have a really good, engaging conversation on the two sides of this issue. One is to keep them in conservatorship, and the other is to spin them out. Jim Millstein, let me start with you. Jim is Co-Chairman of Guggenheim Securities. Why don't you kick us off on the quick intro and any potential conflicts of interest you have, Jim.
Jim Millstein: I had a lot more hair the first time I did a recapitalization plan for Fannie and Freddie. I was in the Treasury Department during the financial crisis, and the last assignment I was given was to take a look at Fannie and Freddie, and figure out how to end the conservatorships. I created a recapitalization plan then, which the powers that be looked at and said, “Really interesting, Jim. We're not going to do that. Not now.” Since then, because I had some knowledge and expertise derived from being in the Treasury Department during that period, I hung around the hoop when Congress tried in the mid-teens to get them out of conservatorship on a legislative basis. During the 1st Trump administration, when President Trump, Secretary Mnuchin, and the director of the FHFA, Mark Calabria, made an effort to end the conservatorships and privatize them, I was hired by Fannie to sit around and help shape the structure of that outcome. Obviously, it didn't happen, and we're now in Trump’s second administration, and it seems pretty clear from all the messaging they're doing that. They're going to give it a good college try. Today I have no financial interests in investors, in any of the securities or in the companies. No relationship with the companies at this point.
Willy Walker: Jim?
Jim Parrott: Yeah, thanks for having me, too. I was at the National Economic Council in the Obama White House and was the housing guy. The way the NEC is set up is, there's one person, a sort of senior advisor, per big issue, and mine was Housing. I was the Housing fella, and we were in the thick of it on the GSEs back in 2009 and 2013 as they were put into conservatorship, and we thought through what to do with them in conservatorship, whether a legislative push was wise and viable, and the like. I left the Obama Administration in 2013 after the first term was over, set up a one-person consulting shop on housing finance stuff, and took up a non-resident fellowship at the Urban Institute. In those two capacities, I still am waist-deep in the GSEs. It's hard to be involved in mortgage finance and not be waist-deep in them. At least, policy-wise, I have no real interest direct in them other than that I'm not invested in the shares or anything, and never have been. As for clients, they're kind of all over the map in their interest in this. I think the one thing clients in the secondary markets and primary market would share is an interest in a stable, liquid sort of agency channel. So, to a degree, that's an interest. They definitely have that interest. So, I suppose indirectly, I do, too, but I have no direct interest otherwise.
Willy Walker: Mark?
Mark Zandi: Willy, thanks so much for the opportunity to be here. I think this is my third time on, so I must have said something half right the last time I was on. Thanks for having me back, and it's great to be with Jim and Jim, who are really good friends that I've known for many, many years. Of course, Jim Parrott and I co-write many pieces and research on this topic, and we've been doing it, I don't know, Jim, since the beginning of time, it feels like.
Jim Parrott: Yeah, it does. We both had a lot of hair. Mine was like this when we started. Mark had some hair then.
Mark Zandi: Sure. It just doesn't stick out like this. Anyway, I'm the chief Economist of Moody's. Moody's obviously has lots of different points of contact with everyone in this space through the rating agency and through Moody's Analytics. I'm on the Board of Directors of MGIC, the largest private mortgage insurer in the country. I'm on the Risk Committee. I had the risk committee and I've been interested in housing and housing finance. I'm an economist. I'm a macro economist. I look at the big picture, but before that, I was a housing finance expert. That's where my subject matter expert expertise lies. Nothing is more fascinating or important as the GSEs. And when you think about it, it's the last unresolved piece of the financial crisis. I mean, the financial crisis was a generation ago, and it scrambled lots of everything, and we've made our way through all that. Actually, Jim was really critical to the auto bailout. He kind of engineered that, and quite successfully. And here we are, a generation later, and it's still unresolved. It's a very, very critical, important topic that's been top of mind for me for almost my entire career.
Willy Walker: Great. No conflicts, Mark, other than being on the board of a mortgage insurer? I've got significant vested interest in all this, being one of the agencies' largest partners. But just to clear off on that, and then I'll do mine quickly, and then we'll head in.
Mark Zandi: I have investments that I know are different places. I have no idea what they're investing in. But I doubt it's Fannie and Freddie. Probably not. No.
Willy Walker: That's great. So, I’m Willy Walker, Chairman and CEO of Walker & Dunlop. Walker & Dunlop is one of Fannie Mae and Freddie Mac's largest multifamily lending partners. We're the largest Fannie Mae DUS lender in the country and have been for the last six years. I have worked with both Fannie and Freddie extensively for my 21 years at Walker & Dunlop and have known every round of CEOs, CFOs, and heads of Multifamily during that period of time, as well as every FHFA director, Head of Multifamily, etc. throughout that period of time. So, I have some deep involvement with both of the agencies, and I do actually own the common stock of Fannie Mae. I owned that pre-crisis and have it today as well. So, let's dive in here, if I can, to the three of you just for a quick one. Are Fannie and Freddie meeting their initial mandate when the two of them were created, Fannie Mae in the 1930s and Freddie Mac in the 1960s today? Really just a yes or no. Are they meeting the mandate as it relates to creating and supplying a liquid secondary market to the U.S. mortgage market in their current state today? Millstein?
Jim Millstein: Yeah, I mean the $7 trillion of outstanding MBS, I think they're providing a robust secondary market for mortgages that are initiated by other people.
Willy Walker: Jim?
Jim Parrott: Yeah, absolutely.
Willy Walker: Mark?
Mark Zandi: Yeah, I think the key here is the ability for Americans to avail themselves of a long-term fixed rate, prepayable mortgage, and Fannie, Mae and Freddie Mac are critical to that. You can see that because you can't get that anywhere else in the world, with a few small exceptions. So, if we've decided from a policy perspective that it's important that we have that type of mortgages as the backbone of the mortgage system, they’re providing that service to us in a very efficient and effective way. Yes.
Willy Walker: So then, if they're meeting their mandate today, what's your biggest concern going forward, Jim, as you look at where the GSEs sit today?
Jim Millstein: We're in the 17th year of a conservatorship which was intended to be temporary. Conservatorships are a vehicle that the regulatory community uses to restore the safety and soundness of an institution in distress. I don't think anybody at the beginning of this thought that this would go on for 17 years, and the problem I see with remaining in conservatorship is there's really no one to talk back to the regulator as we have in other regulated financial institutions: shareholders, boards of directors to engage in the tug of war over policy mandates, and how they're going to be funded, and what a proper rate of return on the required capital to meet those needs are. On the one hand, the governance arrangement is really broken in my view, and the risk, obviously, of leaving them in conservatorship is to see more radical swings administration-to-administration than we've seen over the last 17 years in defining the credit box that they're entitled to serve or asked to serve, the perimeters of the business that they're allowed to do, and the returns on equity that they're intended to achieve. One has to worry that they become complete instruments of policy, and the policy can swing back and forth, creating uncertainty in the market and the essential role they play in this market. That, to me, is why we’ve got to end this madness now.
Willy Walker: Jim?
Jim Parrott: I think the biggest concern I would have right now is disrupting the status quo, more or less. That is, I think, to your question earlier, they work quite well in the situation they're in now. My concern is how durable the current situation is, sharing some of what Jim Millstein just said. Then over the near term, which we'll get into, my most pressing concern is that this administration privatizes them in a way that is overly disruptive and rash, and that undermines the stability of the status quo. So, my goal would be thinking through ways to lock in as best you can what works in the current system in a way that's durable through the political cycle more than the economic cycle.
Willy Walker: Mark?
Mark Zandi: Yeah, I agree with both Jim and Jim. I think the status quo is working well. It's working for home buyers. It's working for the American taxpayer. It's working for the housing market and the economy. But it's not a desirable end state, for the reason that Jim M. gave. I think that it is at risk of being captured by the political process. Now that has not happened in the generation in which Fannie and Freddie have been in conservatorship. So, that makes me less nervous about that. But I still think that's a reasonable concern, given the potential for wild swings in policy. I also agree with Jim. P. Where are we gonna go? And is that better than where we are today? An administrative release (and we can talk about what that means) feels like it's moving everyone in the wrong direction. I think homebuyers will be diminished. I think taxpayers will be put into a less positive place, and I don't think it's particularly good for the housing market or the economy. I have my own ideas as to which direction I would go, but it wouldn't be in that direction. So, if I had a choice between the status quo and an administrative release, that's something we'll have to talk about. In the context of the consensus view of what that means, I think I'd stick with the status quo. We've been here for a generation. It's working. Why do we want to change that and take the risk of breaking something? What's the problem we're trying to solve?
Willy Walker: So, all great perspectives. My perspective is closer to Millstein in the sense that conservatorship has been here for longer than anyone anticipated. There have been, I believe, over 4,000 banks that have gone through the conservatorship process in U.S. history and all, at some point, are returned. They're either wound down, or they're returned to their former state of being either private or public companies. As someone who works with the agencies every day, I have watched the regulator play an outsized role, as it relates to setting the policies versus the executives and the Board of Directors of the Entities. To Millstein's point, as it relates to the governance of the agencies, having a regulator who plays as a regulator rather than a regulator and a conservator, I think we need to get back to having a regulator who sets the rules of the road and allows the agencies to do what they need to do. I think the other piece to it, from my perspective, is the ability to both attract talent, and pay talent market wages. The CEOs of Fannie and Freddie, two exceptionally talented women today, are capped by an act of Congress at $600,000 each. They cannot be paid a dollar more than that. We need to be able to have market wages to be able to have the very best people managing these enterprises. The final piece to it is that, as wardens of the State, I'm very concerned that they're not able to invest where they need to invest, particularly in technology. If you look at Fannie Mae versus JPMorgan, Fannie Mae's existing loan book is $3.6 trillion, and last year Fannie Mae invested in human talent administration buildings and technology $3 billion. JPMorgan invested $9 billion in technology alone last year, $9 billion. And JPMorgan's loan book is only $2 trillion versus Fannie Mae's $3.4 trillion. So, I'm very concerned, as it relates to investments in technology, to keep their risk mitigation, to keep their ability to process mortgages and work with originators like Walker & Dunlop. I'm very concerned that every year that goes by, they fall further and further behind. I have an assumption that if they were privatized, they would be able to invest in the people and the process and the systems to be able to continue to lead forward with such an important role in our mortgage finance industry.
Mark Zandi: Really, can I just…?
Willy Walker: Yeah, jump in, Mark. Go ahead.
Mark Zandi: By the way, who asked you, Willy? I mean, I'm just asking. Yeah. But anyway.
Willy Walker: I'll take that as a compliment that what I just said actually has some reason to it.
Mark Zandi: Yeah, let me say one thing. I want to get on the table because I know you're focused. You're on the multifamily part of the business more than the single family, and my views are really focused on the single-family part of the business, less so on the multifamily. I view those as very different things and very different dynamics. And so that's an important distinction.
Willy Walker: Can I jump in behind that for one second, Mark, before you go to your point? Because I think you're exactly right, as one of the big sort of the pressure points right now, I think the single family market thinks that Fannie and Freddie do 85%. They buy 85% of single-family mortgages today. It's an algorithm-rich business in the sense that if it's a conforming loan, it gets bought by Fannie and Freddie, and off it goes into the secondary market. There isn't a lot of human interaction there. There isn't deal structuring, and they're unlimited in their buying of single-family mortgages. It is completely the opposite on the multifamily side. We are very heavily dependent on the people of Fannie Mae and Freddie Mac. Every deal needs some amount of structure. I just got a stat yesterday that 98% of multifamily lending that Fannie and Freddie do has human interaction. I think it's almost the inverse on the single-family side, and then the final is multifamily has caps on the amount of mortgages Fannie and Freddie are allowed to insure, whereas on the single family side, there are no caps. And so, I do believe you're underscoring an issue that is a little bit of tension in the system, where the single family world sort of says, “If it ain't broke, don't fix it,” and the multifamily side says, “But they could do so much more.”
Jim Parrott: What I was going to say just to reinforce that is much of my concern that we'll get into about the cost and benefits of releasing the GSEs administratively is a single family-specific concern, or at least, it's much more applicable to that. I think the argument and case for spinning them out on the multifamily side is a lot stronger. I think the upside, for a lot of the reasons you've mentioned, is higher and the downside risk of doing it's a little lower, and then the flip of that, the downside of leaving in a conservatorship indefinitely is higher on multifamily side, and the benefits probably a little more modest. I view the utility model that I like on the single-family side, that I'm worried is going to get disrupted as more of a single-family function than a multifamily function. So, a lot of what I'll say over the course of the next 45 minutes or whatever we have left is somewhat unique to the single-family side. So, Willy, it's probably important for you to clarify and remind folks when I run my mouth about stuff that I'm probably talking about the single-family side. In some cases, it won't apply to your world as well.
Willy Walker: Understood. Mark, you were gonna jump in a moment ago.
Mark Zandi: One quick thing! This goes to a point about investment on the single-family side. I think we don't want a complicated entity there. It's a very simple entity. It takes liquidity and credit risk and just transfers it. It's a risk intermediary, and it shouldn't be holding or retaining risk. And, in fact, to a broader point, the GSEs have already been effectively privatized because of the credit risk transfer process that they've engaged in. And this goes to something else that's important: the concern that they're not going to innovate and won't innovate because they're under conservatorship just belies the reality of what they've done since they've been put into conservatorship. Think about how they've invented the CRT market. They invented reinsurance in the mortgage credit space. They invented the single security. They invented the common securitization platform. And now, most recently, the whole foreclosure mitigation process that they put in place. It's really a beautiful thing, so I don't think you can sit back and say they haven't innovated and kept up and invested and done the things they need to do. They don't need to be Goldman Sachs. They don't need to be JPMorgan Chase. They are intermediaries of risk. They take it from over here, and they put it over there in the private sector, and deliver a 30-year fixed rate, prepayable mortgage to middle America and low-income Americans.
Willy Walker: Jim Millstein?
Jim Millstein: No, it’s all true. I mean, look at it. It's a testament frankly, to the success of the conservatorships that the really risky part of the business has been reformed, right? I mean, the government-sponsored hedge funds that they ran pre-crisis are all gone. They're down to less than $100 billion each in their portfolio and their transaction portfolios, buying mortgages to pool them, to securitize them, refinancing themselves with the sale of MBS and buying mortgages that are delinquent or defaulted out of those MBS. That's really all they're doing these days, exactly as Mark suggests they should be doing. I think the question is, would we be better served, again with a regulatory definition of the perimeter that they're allowed to operate in, by having an arm's length relationship between board and shareholders and regulator, than having the regulator as conservator have all the power of the companies? I think we believe in America that private capital, with the incentive to profit also creates an incentive for efficiency in the operations of these entities. In the case of large financial institutions such as these, with systemic importance, having a rigorous regulatory framework around them to ensure that they serve the purposes for which they were chartered, but nonetheless have somebody to represent them in front of the regulator to create the tension that is necessary for innovation and advancement, I think, is critical.
Willy Walker: So let me jump to this because I want to get to the guarantee and the structure of the guarantee, and what have you, to move to that. Let me just put this forth. The status quo would be the status quo. There's a hearing tomorrow in the Senate Banking Committee for Bill Pulte to be the next FHFA Director. Fannie and Freddie both have Boards of Governors. They both have CEOs. There's a new Head of Multifamily coming in on the Fannie Mae side right now. The bottom line is, that would be business as usual, and that's not much of a debate. Obviously, Bill Pulte will be asked lots of hard questions tomorrow such as “If they are to stay in conservatorship, how he would act as regulator of them?”, but not a lot to debate there. We'll see what happens. So, let's just take it that they are put on the path to privatization, because in the first Trump administration, Mark Calabria and Secretary Mnuchin made significant efforts to try and get them out of conservatorship. They did not succeed with that. Mark Calabria is on the record as saying that had the pandemic not hit, they would have been successful with that. And then, President Trump, in a 2021 memorandum, said Fannie and Freddie shouldn't be part of the federal government. They ought to be spun out. And so, there are records there of efforts in Trump 1 as well as in 2021 from the President himself, saying, these things ought to be privatized. So, if that effort gets on track and they're going to head down an administrative route, or they're going to head down a legislative route, Jim Parrott, can you briefly just explain the difference between a legislative route and an administrative route, so that we can just get quickly to whether it's going to go left, or whether it would go right, and what the trade-offs are about going down one path or the other?
Jim Parrott: Sure. If they go down an administrative route, then they'll pick up largely where they left off last time, which is making sure that Fannie and Freddie build enough capital to get closer to the regulatory capital levels; they’re way off from that. Still getting closer, they'll have to think about how to go out and raise more private capital to supplement what they've already got held. They'll have to increase the powers of the regulator to be a more appropriate post-conservatorship kind of regulator. This is something Calabria is very focused on, and they've got to clean up the capital stack. They've got to figure out what to do about the government's current $335 billion senior preferred position and the warrants they've got. It's hard to imagine how you're going to raise much private capital in a world in which the government's got that kind of stake. So, they've got to figure out what to do about that. They’re going to have to figure out, if they were going on the administrative path, what to say and do about the government's backstop, if any, beyond the current lines of credit they've got to the Treasury Department. They've got significant lines of the Treasury now that are explicit in contract. Assuming they keep those post-conservatorship. There's a little bit of debate about that, but I think probably not much. It's hard to see how they're viable without that line of credit, the Treasury. There's a question of whether or not there's an implicit guarantee, a complicit backstop beyond that contract, which we can talk about a bit. A lot rides on that. So, if they go down the administrative path all the way, they've got to clean all that up to eventually get to a point where they bring them out of conservatorship. They might have to bring them out of conservatorship under a consent order, and by that I mean, if they don't feel like they can get to adequate capital levels prior to bringing them out of conservatorship, they could bring them out under a contract that would effectively allow FHFA to maintain conservatorship-like oversight over the GSEs under contract as opposed to under regulation. Once they're out of conservatorship, and then, once the capital levels get to a certain trigger, those constraints are lifted, and they go to being a regular regulator. So, these are things that Calabria and company were thinking about last time. As for the legislative track, there are 101 iterations or permutations of that. The one they would likely focus on, I think, they'd make a run at this. I don't know how futile it would be. They made a run at it last time. As Mnuchin and Calabria did earlier, they would be probable to take the mousetrap I just described, which is status quo, tilting right a little bit, as Trump would do it, probably adding an explicit guarantee at least to the MBS, perhaps even to the solvency of Fannie and Freddie. We could talk about how that's distinct and maybe important, and probably opening up the charter authority for other guarantors. It's something conservatives have always talked about. They like the idea of a multi-guarantor model. We have lots of Fannie's and Freddie's running around. We can debate whether or not you'd see anybody take them up on that offer. But the two things you would almost surely see them push for legislatively would be an explicit guarantee, and the ability to charter additional GSEs.
Willy Walker: Okay. So, I want to jump to Millstein as it relates to capital levels. And then I want to go to Zandi, as it relates to guarantees. So, Jim Millstein, can you jump off of what Jim Parrott just said. Keep us focused on the administrative path. Only in that it's likely quicker. The legislative path has been banged around. Now for over a decade, Congress has had the opportunity to get itself either a Democratic House and Senate or Republican House and Senate, or, you know, split to get something done. They haven't. So, many believe, handicapping, that French Hill, who runs the House Financial Services Committee, and Tim Scott, who runs the Senate Banking Committee, both know a lot about this issue, but they’re unlikely to chew up a whole lot of time trying to get legislation put together. So, let's focus on the administrative path and capital levels, because right now they need to have 4% risk-based capital in the current mandate from FHFA to get them spun back out. Do you think 4% is too high or an adequate amount? And how and when could they possibly get to that 4%? Or would you look at something lower at 2.5%, which they're actually not that far away from?
Jim Millstein: The 4% is just the minimum capital level under the existing capital rule. When you look at the stability, the various buffers that they're required to hold on top of tier-one common, you're talking double that amount into about 10% of risk weight capital. The capital rule that was devised during the conservatorship is really a capital rule based on the capital rules for banks. Banks are obviously way more complex. They take a greater diversity of credit, liquidity, interest rate risk than these relatively simple organizations. So, I think one thing that an administration intent on going the administrative route would be to revisit the capital rule, not to lower the hurdle to a senseless, risky level, but to actually set the capital rule to something that is more than adequate for the risk they run. The Dodd-Frank Act stress tests that have been run on the entities suggest that even in a housing crisis like we had in 2007 and 2008, the losses that these entities would suffer, given the quality of the single family book today and the absence of any of the alt A subprime securities they had on the balance sheet in 2007 and 2008, would be minimal, less than $10 billion in the aggregate between the two of them on $7 trillion of outstanding single family guarantees. So, whether they really need to have 10% of risk weighted assets as a capital buffer to run the risks that result in a $10 billion loss is, I think, really questionable. But that's it. Let's assume for the moment no changes to the capital rule by the end of 2026. So, in the second year of the second Trump administration, they would each be adequately capped, they would each have reached the level of common equity tier-one capital necessary under the existing capital rule. In order to become fully capitalized under that rule, Fannie would need to raise somewhere between $30 to $40 billion of incremental equity, and Freddie somewhere around $25 billion of incremental equity to common equity. So, as Jim says, if you really wanted to get them out as of the end of 2026, and take all the steps necessary to set up a new post-conservatorship regulatory regime, Jim and I, Mark, have talked a lot about what that would look like, a utility framework. That's work that has to be done at the FHFA. There's some interagency rule making that needs to be done to ensure that the banks can continue to hold exposures against the privatized entities as they do today. As Jim said earlier, if you really wanted to do all that legwork and spin them out as of the end of 2026, it would need to be done, based on a consent order giving them time to rebuild their capital. Now they're incredibly profitable right now. So, if you wait until 2028, and just let them retain their earnings through the next four years, they probably get to full capitalization without the need of any equity offering. So, you could do this in a more deliberate fashion, and take the risk of a public offering out of the equation. But the ability to demonstrate access to the equity markets is going to be critical for Mark's colleagues on the rating agency side, because if they're privatized right, the advantage of being privatized is you have access to the equity capital markets and the unsecured debt markets. I mean, they have access to the unsecured debt market today, but to demonstrate access to deep equity capital markets will be critical to the stability of the rating. So, whether or not they're fully capitalized or merely have met the level in 2026 of common equity tier-one capital, it will be important to do a demonstration to the rating agencies that the equity markets will welcome them back as issuers and feed the pipeline that's going to be necessary, if not to rebuild capital, but to give the government itself an exit and that there is a robust market that the Government can access to sell whatever percentage of the common equity it ends up with. The government's going to end up with, on my math, somewhere between 90 to 98% of the common equity. Sorry about that, Willy.
Willy Walker: No, it's great. I want to go to Mark. As you hear Jim, talk through capital standards and your concern as it relates to where Fannie and Freddie's debt and the MBS trade, and the widening of that with a potential release from conservatorship. Two things: The first is, do capital standards really have any impact on that? In other words, if it were 4%, if it were 3%, if it were 2.5%, it's really the guarantee. And whether there's an explicit, implicit, or no guarantee, that is going to change the bond pricing. The actual balance sheet capitalization, while important, long-term really won't have a big impact on that first look from a rating standpoint and from a pricing standpoint. Then, go into your thoughts, as it relates to implicit versus explicit versus none.
Jim Parrott: Oh, boy!
Jim Millstein: Yeah, 5 minutes, Mark. 5 min, exactly.
Mark Zandi: Maybe I'll just broaden it out a little bit to make it more relevant to folks. In my view, if the GSEs are released administratively, as is commonly thought in public discourse, it means they would be released with the PSPAs. You know, they would be SIFI-capitalized. All the things that Jim and Jim were talking about—those would be part of that. Also, the PSPAs would come at a cost; it wouldn't be free. They'd have to pay for the government backstop going forward. Mortgage rates would be higher in that administrative state than in the status quo.
Willy Walker: I disagree.
Mark Zandi: Yeah, okay, that's fair. But it's just a question of how much higher, by my calculation and it's a rough calculation, there's a lot of moving parts. And again, it depends on what you mean by administrative release. I think, for the typical borrower, meaning in the middle of the credit distribution in a through the business cycle, not in a stress environment, but in the business cycle, the 30-year fixed rate would be 20 to 40 basis points higher than it is today now for the folks on the edge of the credit distribution. In a stress environment, the impact on rates would be higher, and high enough that I think affordability would be a real issue. You'd see a narrowing of the box of the availability of credit; it'd be less available to Americans, and that goes to MBS, yields, the GP, and we could talk about capital. I'm sympathetic to what Jim is saying about capitalization, that it feels very high. But so does capitalization in the banking system. Talk to Jamie Dimon about capitalization of JPMorgan Chase; he's going to say, and he's got a case, “It's too high.” I get it. But that's the world that we live in. And the GSEs, if they're going to be released in our SIFI, and they are systemically important, they’ve got to be treated in the same way as the other guys. They're not the same as the other guys. But in that context, they've got to be treated similarly. So, you're going to have a higher capitalization. And I would also argue that their implicit return today, even at the high capitalization at which they're functioning, is too low for them to actually go to market and get all the things they need to get done to become the private publicly traded institutions. Again, they're going to need a higher return, and the GP is going to be higher than it is today, in my view. So, I think, fundamentally, the status quo is better than the administrative release. Final thing I'll say, and I'll stop. I don't think that's the end state. I don't like that, either. I would codify the current system. I turn them into government corporations and bring in private capital saved through preferred shareholders. You can go back and take a look at a series of papers that Jim P. and I wrote back in the day promising road pieces. You can. You can Google it. And we lay this out. We do believe that these should be institutions out there in the public domain, but through a different means, through an explicit guarantee. And, by the way, you have an explicit guarantee mortgage rates will be lower than they are today, because right now the guarantee that they have is better than an implicit guarantee. But it's not an explicit guarantee. So, if I were king, that's the direction I would head.
Willy Walker: So let me ask you a question here, Mark. Looking at the last 40 years’ single-family spreads on agency MBS, borrowing rates to the borrower have averaged between 165, and 175 basis points over the 10-year treasury. Today, they sit at 265 basis points, and during 2024, they sat at over 300 basis points spread between treasuries and borrowing rate to the single-family consumer. So, why, with that dramatic gapping out on the single-family cost of borrowing, do you think that if they got spun, they would have an actual incremental 40 or 50 basis points on top of where we are today?
Mark Zandi: Well, I said, 20 to 40 basis.
Willy Walker: You said 20 to 40 on top of where we are today. So, we're still a hundred basis points.
Mark Zandi: All those dynamics that are behind the widespread, the 250 spread, by the way, just a factoid, I find fascinating. Maybe nobody else does. But in a given week, two months ago, the mortgage spread was wider than the high yield corporate debt spread for the first time in history. That shows you how wacko things are, but all the things that are wacko that are causing that spread to be high, all the volatility and inflation, uncertainty, and maybe even this talk about release, are starting to play a role in spreads. I mean, it is affecting the stock price. I haven't teased it out, but maybe one of the reasons why the spread’s wider is because of the talk around release. All those things don't go away, you know. If you release them administratively, they're still there. And then, on top of that, you've got all the things I just discussed previously. You get a higher mortgage rate.
Jim Millstein: Can we just test that a little bit, Mark, because, assuming the PSPAs remain in effect post- conservatorship, that they reach these crazy capitalization levels 10% of risks, weighted assets, which is your SIFI level, a bank-like SIFI level, what is conservatorship adding that gives to the credit risk associated with these entities? What is it adding that would not be there post-conservatorship?
Mark Zandi: I think a lot of things. I think it provides stability to the single security; it provides stability to the function of the common securitization platform in the TBA market. I think it's important to the well functioning of the MBS market in general. I mean, I think MBS investors would say the guarantee they're receiving in conservatorship is greater than the one they would receive administratively. I think that's the case. By the way, just to reinforce a point, in the current status quo, the GSEs have been privatized. The risk that's being taken is going back to private investors. It is already privatized.
Jim Millstein: We should explain that to people who don't understand that the creation of the credit risk transfer market has effectively transferred in the case of, you know, somewhere between 55 and 35% of the actual credit risk embedded in that $7 trillion of outstanding MBS depending upon which entity you're talking about somewhere between 55 and 35% of that credit risk has been transferred to private investors through the so-called credit risk transfer market, which is an innovation that occurred during the…
Mark Zandi: Jim, can I just say on that point, it should be higher than that and it's not because they want to retain the…
Jim Millstein: This is an exact point of the weight of the political risk, right? So, we had an administrator who was all down with this and said, “Go for it. Invent this credit risk transfer market,” and then we had an administrator who said, “I hate this. Stop it.”
Mark Zandi: Yeah. But think about what these guys would be like in a world where they're on their release. They would have less of an incentive to actually transfer that risk.
Jim Millstein: That's crazy. That's crazy.
Mark Zandi: And, by the way, another quick point about the reason why I asked about the status quo. What I like about the status quo that we'd be giving up is, go look at what happened during the pandemic. Think about the world shut down during the pandemic, and Fannie and Freddie immediately came to the rescue. Why so quickly? Because they were in conservatorship. That would not happen if they're released administratively. Now, I'm not saying that's a reason not to go down the legislative path and get an explicit guarantee. But that's something we would definitely be giving up. And historically, that's a role Fannie and Freddie have always played.
Willy Walker: They played it. I don't understand why you think that they're not going to roll the tape back to the role that they played pre-GFC. They did exactly that in the dot.com bust.
Mark Zandi: They can't, because back then they had a balance sheet they could use to acquire the securities, to provide stability to the financial system. In a time of crisis, they will not have that ability, presumably, I would think.
Willy Walker: That's back to why?
Mark Zandi: That goes back to one of the reasons why no one should be deathly scared of an implicit guarantee. If we go back to the kind of balance sheet that the GSEs had before the financial crisis.
Willy Walker: Right, which was when they dove into, and apparently I'm coming to you right after this, but that is due to them diving into all day loans to try and get back to the earnings growth that they had historically had throughout the 1990s and into the early 2000s. A clear mistake by the management of Fannie and Freddie to dive into that part of the market to hold that risk on the balance sheet. But, as Millstein said very clearly, they've taken credit risk transfer to a whole new art form. You said it yourself, Mark, and they've got that in place, and they're laying off that risk. One of the challenges, I think, from privatizing them right now is to get their ROE to a level that private investors will want to invest in, because what they've done is, rather than holding that yield and holding that return, they've sold it off, which has actually diminished their return profile that has them now, both in mid single-digit ROEs. They actually would need to figure out how to bring that up, if you wanted to attract private capital into their IPOs. But Jim Parrott, go ahead.
Jim Parrott: Yeah, it's worth taking a step back and reminding, at least for viewers, what it is that the GSEs do and what we would like them to do, because once you define a little more clearly what the organizational structure ought to be, an ownership structure ought to be, it's a little easier to talk about that and debate about it. I think of the GSEs’ functions as sort of falling into three buckets. First and most importantly, they take all of the catastrophic credit risk out of their channel. This is a single-family thing; multifamily is more complicated. On the single-family side, they take the catastrophic credit risk out of the channel that attracts trillions of dollars of MBS investment you probably wouldn't see otherwise. Second function, they manage much of the mortgage finance, infrastructure in the market, connecting primary and secondary markets up, and then third, in virtue of the market power they've got from functions one and two, they largely define who in the country can get a mortgage, and on what terms. The first function is a government function. They can farm that out or get the private sector to provide it. But the MBS investors that need to see the catastrophic credit risk pulled out of the market simply don't believe a private company can do that. The government's got to stand behind that for them to provide that function. So, that's a government function. Whether they farm it or not, it's a different question. The third function, this whole defining who gets to get a loan, on what terms, that's a policymaker function; that shouldn't be purely a private market function. That's very much a question of who in this country ought to be able to buy a house. And then the second function, to me, is a debatable private market/government kind of function, which is managing a big, complicated set of infrastructures like the GSEs do. On the one hand, do you want Goldman Sachs-like compensation to handle and incentives to drive the institution that handles that? Yeah, I'd rather have that than FHA-like compensation levels, to your point, Willy. On the other hand, when you're giving that responsibility to a single company or companies, you're giving them overwhelming market power and the risk there, of course, is whether they use that market power to their advantage, to their ROE's advantage, the shareholders advantage, or to the national interest advantage. And so, when you take those three together, effectively defying the credit box, managing the infrastructure, the mortgage market, and taking the tail risk out of the channel like you're right at the intersection of what is, arguably, the private market and what should be a government function. So, there's this tension between the two. So, to your point, Willy, if you really wanted to be purely private market, it gets to be really complicated because you're giving them such dominant market power, their incentive to push the edge of what we give them, to drive to the edge of what's good for their shareholders at the expense of market stability, financial stability, and all that is a problem. At the very least, you have to regulate the bejesus out of that system, which pulls away some of the dynamism you get from privatizing it to begin with. So, there's a bit of a trade off, and if you were to take them into a government corporation kind of direction, the thing that Mark and I explored a while back, you've got to find a way to do it, in a way, it is FHA. So, you're at this intersection between needing private dynamism and capital and needing a really heavy hand of utility-like model from the government to make sure that they're doing this in our interest as taxpayers, as folks that want to go out and buy a home. I think that's part of what's going on. The tension between the two models.
Jim Millstein: Just to take you up on the challenge of that, if the utility-like regulatory structure that was created for the post-conservatorship environment addressed that fundamental point that they shouldn't be able to swing for the fences, they should stay within, in effect, the monopoly or duopoly parameters that they've been given and franchised to serve, it seems to me that there is a regulatory framework that can address that. It's not quite the rate setting mechanism from the gas and electric utility industry, but it is a GP regulatory environment where you define the ROEs that they're permitted to earn, and therefore to set GP at a level to earn that, and to the extent they earn in excess of that, the government can sweep that as part of the cost of the backstop—can sweep 100% of it or 50% of it, or 75% of it. But over that level, the government gets an excess return, and under that level the investors are assured that the government's not gonna pull it all out, so that you can attract private capital, so that you know the FHFA’s regulator, as supervisor of GP levels, ensures investors that there's going to be an adequate rate of return on capital and ensures the government and market stability that these guys aren't going to swing for the fences again and load up on all day in order to juice their returns.
Willy Walker: A question along those lines is in the theme of, if you will, make America great again, the things that the Trump administration has taken on in the first six weeks of the administration, is the government guarantee explicit, implicit, but which, as Mark said at the top, allows for a 30-year, prepayable fixed rate mortgage to exist in the United States, which exists in very few places around the world, and was quite honestly one of the main drivers of U.S. economic exceptionalism in 2021 and 2022, post-pandemic when the rest of the developed world had much smaller GDP growth than we did, because people had floating rate home mortgages and were getting choked by the cost of those floating rate home mortgages versus in the United States with over 80% of people with a long-term fixed rate mortgage under 5%, shouldn't we think about that guarantee as something that we want broader access to, that it's a real value to the American citizen whether they're a single family homeowner or a multifamily renter? Or am I looking at this wrong, Mark, as it relates to “no, we need to constrain that, and only needs to go to the most needy.” But we should allow the private markets to operate in the jumbo loan market, secondary home market, multifamily loan market.
Mark Zandi: I agree with you about your point, about the fact that U.S. households were able to lock in, and that saved the day, or was a big part of why the U.S. was able to navigate through, and the rest of the world had recessions or came pretty close. Fannie and Freddie account for what? 40, 45% of the market today? That's kind of typical, I think. Historically.
Willy Walker: Both pre and post caps, so their lending level on multifamily has not been relatively constrained by the caps; they've been around that market share pre and post caps.
Mark Zandi: Right. And I was talking single family. But then, FHA, you know what? 15 or 20%. So, the rest of the market is 20,25, or 30% at points in time. I'm obviously making the numbers up.
Willy Walker: You're about right.
Jim Millstein: I think it's higher. I think the Fannie Freddie market share today is higher. It's more.
Mark Zandi: It's higher than that. Okay? Not surprising.
Jim Millstein: 70% of the market.
Mark Zandi: Okay. So, that feels like a pretty expansive use of the government's backstop and balance sheet. I mean, if you look at the cost of providing this service to the American homebuyer according to Correctional Budget Office CBO, the subsidy is about $5 billion per annum. So, the taxpayer current framework through the cycle is providing $5 billion of subsidy via Fannie Mae and Freddie Mac to provide this service of a long-term, fixed rate, prepayable mortgage. So, $50 billion over 10 years. That's the last time they did the estimates, probably on the high side right now, but that's probably where it is. That gives you context that we can debate whether it should be higher, should be lower. That's where it's been, feels pretty good, system was working well for everybody, and it's working well for the economy. So, I'm not sure that's where I would be focused in terms of this conversation and the debate.
Jim Parrott: Yeah. But let me follow up on that. I think, Willy, you're 100% right that a large government footprint, when you include the GSEs and Ginnie, is better for systemic stability. It's better for ensuring broad access to mortgage credit. It's better for systemic stability. Because imagine if we'd gone through the pandemic and the PLS market was 40% of the market, and the government couldn't get to that part of the market. We ran into this in the Great Financial Crisis. And it was an enormous problem, because trying to help those whose loans were servicing the PLS market, we just couldn't get to them in any sort of effective way. So, fast forward to the pandemic, and luckily, we had most folks within the government footprint, which made it much easier to help them with loan mods and all the rest. And so, it's easier for the government to be active. It's easier for the Fed to be active within the government footprint. For those that are on the other side, it's just a bit of a No Man's Land, or has been historically, and it allows for some cross-subsidization. If you've got a broad government footprint, it's just a lot easier to help those that are at the bottom end of the market leg into a mortgage. So, whatever one thinks about the government ownership, or private ownership, or whatever of the GSEs, at the end of the day, assuming that involves some level of guarantee, implicit or explicit, the broader you can make that footprint, the more stable and liquid this whole market is, and the better off we all are. I think it's been one of the lessons I think we've learned in the last 10 years.
Willy Walker: Which is counter to a lot of Republican thought on this issue. Back in 2011, 2012, when plenty of members of Congress were like, “you know, we want to wind down Fannie and Freddie, and we want to get out of being in the guarantee.” Let’s jump to one thing because Jim Parrott and Mark Zandi both said that they believe that they can't be spun without an explicit guarantee. One of the things that comes with an explicit guarantee would be the federal government taking on the explicit liabilities of Fannie and Freddie. So, I think one of the things that Jim Millstein and I are proposing is, keep the implicit guarantee with the scaffolding around it that tells investors, “If the you know what hits the fan at some point in the future, the Federal Government will step in just like we all know it would step in behind JPMorgan and Bank of America, even though it's not an explicit or implicit guarantee behind those SIFIs. We know they'd step in to prop them up. They did it in the Great Financial Crisis. They'd do it again, but that you keep those liabilities off the federal balance sheet in this implicit nature, where you have an implicit guarantee with a scaffolding around it.” Mark Zandi or Jim Parrott, jump on that and say that doesn't work, why it's got to be explicit, and we'll take on the liabilities as a cost of that explicit guarantee.
Jim Parrott: A couple of things, and then I'll let Mark sort of clean up the mess that I'll create my answer. There are a whole host of government obligations that have the feel of what an explicit guarantee might feel like that are not on the government balance sheet. Ginnie's not on the government balance sheet. FHA is not, FDIC's obligations aren't. I don't think student loans are. So, it depends on how you set up the explicit guarantee as to whether or not it goes on the balance sheet. We ran into this in trying to figure out what Obama's position was going to be on a legislative reform, and the lawyers and the capital markets guys at Treasury came up with different ways in which you can keep it off the balance sheet while making it explicit. I think the Calabria folks came to the same conclusion. It's a design challenge more than anything else. But at the end of the day, you want the market to believe that the government stands behind this stuff. Whether or not you can come up with a cute way of like a wink and a nod, and telling, like the accountants, that they're not on the government balance sheet, but the market that they are, I mean, it seems like it's a bit of a regulatory arbitrage there. That is a little unnecessary. Better to have Congress come in and clean the whole thing up, assure the market and everybody else that the government is indeed behind this. We'll pick up a few basis points and where MBS will trade more like Ginnie's than it does Fannie and Freddie's because of that added clarity, and you avoid the possibility that you wind up in a financial crisis with someone like Calabria that might actually let the government see them go down and say, “You know, sorry, we're not going to actually step in and bail them out. Under these circumstances we think that they ought to learn a lesson.” I think that's a bananas kind of outcome; it's a low probability kind of outcome. But why actually allow that to be a possibility at all? Why not, if you've got a chance, at least have the government step in and clean it up and say, “Look, you know we've been on the hook for this stuff all along. Let's make it explicit. Give the market comfort with it, and just own it, because, you know, for the market to work, the government's got to own it. In any case, we might as well be explicit about it.”
Willy Walker: Mark, I'm coming to you right now. Just one quick thing on what Jim just said. Hank Paulson was no fan of the GSEs and decided to take action because as Treasury Secretary, he said, “I got to shore these things up, or I got a much bigger problem on my hand.” So, while I hear you saying we don't want to be at the point where someone who isn't a big fan of the housing finance system, or whatever else, sits in the seat and has the power over it, I don't think Hank Paulson was sitting there saying, “I love the agencies and want to support them.” He saw them as a fundamental part of the overall health of the U.S. economic system. Mark, jump in.
Mark Zandi: Yeah, I was just gonna say something cute, so I won't say it.
Willy Walker: Oh, okay, but I was coming to you to jump on behind.
Mark Zandi: It really would have been nice if I could have said it when I wanted to. Sorry. No, no, don’t worry. I’m just talking.
Willy Walker: I messed up. We are almost out of time, which kills me because we're just getting into the meat of this issue. And I want to be respectful of everybody's time. I think what we're gonna have to do is a part two because I don't think that this issue is going away anytime soon, and it's going to start to evolve as they start to put these things either on the path or not, as the case might be. It will be interesting to hear what nominee Pulte has to say tomorrow, in his confirmation hearing in front of the Senate Banking Committee. He's going in front of them with Jonathan McKernan and Jonathan Mckernan is up for head of CFPB. And so, as I think about someone like Senator Warren, who probably has some pretty strong fastballs to ask of Mr. Pulte, something would tell me that she will take the majority of her fastballs and send them down toward Mr. Mckernan, as it relates to CFPB and less so on FHFA. But we will see how all that plays out tomorrow. Let's do this. Some parting thoughts, just because we are at the bottom of the hour. Millstein, I'll start with you. And then what I'm going to do is I'm going to say, let's do a redo of this in a month or two, and see where we stand, and dive into some of the things that either look to be wildly either assuring or concerning, as it relates to the path that they seem to be on, and the socialization process, or not, that they are undertaking. Jim, let me turn to you.
Jim Millstein: Just from a personal point of view, I would love to actually work on the deal as opposed to participating for another 17 years in these kinds of conversations. I mean Mark and Jim and I have been at this, debating these various points, and there's nothing like the focus of actually trying to change an existing system, to take what's good from it and make it persist, but end what is clearly a situation that none of us believes is the ultimate end state.
Willy Walker: Jim Parrott?
Jim Parrott: I actually think there's more commonality and agreement among folks on this call and a lot of folks that are in this debate than people appreciate. We tend to focus on where we disagree, but the end of the day, I think we share a common set of objectives about what we think the GSEs ought to be doing, and it's really a question of design as much as anything. I think if you got in a room, you could come up with a design that would largely meet what all sides of this debate agree is the right way to actually get to our objectives. I think that's worth remembering as we get into the short rows, as it were, with the Trump administration, because they may not share the same objectives. So, it may actually be worth coming together to clarify what actually works in the system, and what doesn't, so that whoever is driving the bus here in another six months doesn't drive us off a cliff.
Willy Walker: Mark?
Mark Zandi: Well, thanks again for the opportunity. It was so good to be with everybody. We live in an incredibly uncertain world. I mean, I've been a professional economist for 35 years, and I've never seen anything like what we're going through right now. On every single economic policy front, there is a high degree of uncertainty. The housing and mortgage markets are under significant stress for reasons that have been built up over years and decades. As good as Jim M. is in making a deal, do we really need to go down that path? Go through all the uncertainty that this will create in a world of incredible uncertainty? I just can't imagine this is going to go well. I hear you. I don't want to be here a generation from now. By the way, I won't be here a generation from now; that's someone else's problem. But I'm just saying that's much better than going down a path that's potentially very vexed.
Jim Millstein: I think we can make you comfortable, Mark.
Mark Zandi: Okay.
Willy Walker: So I would just close out, Mark, on saying this in somewhat of a response to what you just said. As a very significant partner to the GSEs and their multifamily business, and quite honestly, having market share that is very large, and the envy of many of our competitors, you would look at me and say, “You know, why aren't you just out there going for the status quo? Just keep things as they are.” And as I look at it I'm concerned about what Jim Parrott said. I'm concerned that there is a spin out that doesn't take into account all the things that we talked about. So, that's number one, as it relates to a concern. They need a guarantee implicit or explicit, and it needs at least the sense to the market, which both you and Jim have written extensively about, that says that the full faith and credit of the United States Government may not be printed on the bottom of this MBS. Certificate, but you have a sense that it is there should it be needed. But the other one is that, change is always challenging. But I've been waiting for 17 years to deal with the change that was going to come. Once they went into conservatorship, I was one of those people who was sitting there the day that they was announced they were going into conservatorship and said, “Is my business going to go under tomorrow, or is my business going to flourish tomorrow?” And literally looking at that, and saying it could be that binary that they could either go away. And they're done writing mortgages to multifamily, or all of a sudden, we end up growing into are what we are today. But I do sense that while it works clearly today, I'm concerned where the status quo is a decade from now, two decades from now, and the lack of investment to continue to keep up in a wildly evolving world. And so that's sort of where I sit, as it relates to, “Do you want to take those risks?” Many people would look at me and say, “Why would you ever think about taking on those risks?” I think that's sort of the world we live in, and that's somewhat why I'm sort of the pro spin route. I want to thank the three of you. You all know so much about this. Each one of you could have talked about this for the full hour on his own. I do want to pull us back together as we see how this evolves, and jump right back in at that point, and not have to go back through all that we've gone over today. But to the people who are listening, I hope you found this as engaging as I did. Thank you, Jim. Thank you, Jim, and thank you, Mark, for your time, and I look forward to seeing everyone next week on the Walker Webcast.
