After Fannie Mae and Freddie Mac released their proposal for a new rulemaking to establish modernized minimum regulatory capital requirements for the two companies, Former Freddie Mac CEO Don Layton released a reaction to the move.
"What emerges from the proposal is a vision that looks to be politically or ideologically driven in several key ways and, curiously, a reversion to an earlier era of financial system design," said Layton. "This, of course, fits perfectly well into how highly politicized most things about housing finance and the GSEs have long been. Surprisingly, the capital proposal works directly against the GSEs being able to raise equity to exit conservatorship, despite Director Calabria, the FHFA’s head, having indicated that such an exit is his highest priority."
According to Layton, the proposal is "thorough, thoughtful, and very complicated." He notes that the 424-page long document builds upon the 2018 proposal, but is mostly new and changed in significant ways.
Layton speculates that the GSEs' proposal "is going to hurt the equity-raising needed to exit conservatorship."
First, Layton says, the companies will need to raise equity in amounts never before done, by an even larger margin than expected. Second, the projected return-on-equity (ROE) of the companies, which is the single most important measure of financial success for large financial institutions, will be under-market, and thus render the shares in any IPO unattractive, until enough years have gone by to show that increased g-fees and other impacts of the capital rule proposal are able to generate an ROE of at least 8 to 9 percent after tax.
"Third, the increased pricing required to deliver a return on the $243 billion level of capital will shrink the GSEs’ market share, leading to declining revenues and profits, which investors will not like," he adds.
"To conclude, this proposal has a lot of good detail and depth to it," says Layton. "However, at key junctures it is strategically backward-looking or driven by ideology more than is appropriate. I hope it receives many comments from interested parties to generate significant reworking, with the result that it develops a reputation as professional rather than political, right down the middle of the fairway. Otherwise, it risks becoming a political football, like so much about the GSEs and housing finance, likely to be significantly revised every time a new FHFA director from the other party is appointed."