The GSEs Path to Becoming ‘Investment Opportunities’

In September 2019, President Donald Trump and his administration initiated a process whereby GSEs Fannie Mae and Freddie Mac would exit conservatorship. Former Freddie Mac CEO Don Layton, now a Senior Industry Fellow at Harvard's Joint Center for Housing Studies, two weeks ago penned a paper in which he opined that the White House waited too long to start and finish the entire process, which should involve keeping key reforms developed over the course of conservatorship (since 2008) in place.

"The two government-sponsored enterprises Freddie Mac and Fannie Mae have just entered into their thirteenth year of conservatorship, despite the fact that it was originally designed as a temporary time-out," Layton wrote in a follow-up essay.

He points out, somewhat critically, that the administration aims to complete the conservator exit processes sans new legislation.

"This requires the Federal Housing Finance Agency (FHFA), their regulator and conservator, and the US Treasury to both separately and together make decisions and take actions involving extremely large amounts of money in an incredibly complex, never-tried-before process with many political sensitivities," he noted. "To implement an unprecedented undertaking of this scale and scope, the FHFA and Treasury are, in reality, mostly figuring out how to do it as they go along. To date, even though the implementation of this “by administrative means” plan began a little over a year ago, it has so far only scratched the surface—and so likely has years to go, with many tough and complex decisions still to be analyzed, made, and implemented."

He goes further into depth regarding the complexities. For example, Layton wrote, "as part of this implementation, the GSEs will need to build up an immense amount of capital. The current proposal by FHFA for a new capital rule would require over $240 billion; even alternatives that are less strict are at $150 billion or more."

The money would come from both retained earnings and new equity issues, he said. Putting the amount of money in perspective, he said, the largest IPO in American securities market history was just under $18 billion.

"So, unless policymakers are going to be extremely patient and wait a decade or more for retained earnings to accumulate, there are likely going to be several record-setting common equity issues required," Layton said, "and possibly more than one for each GSE."

Layton's paper “GSE Re-privatization: Will Washington Scare Off Private Capital?” describes what the companies today represent as an investment opportunity and explores the government’s plans and actions to determine whether "they are consistent with making the two companies attractive enough to equity investors ..."

In the paper, he describes many scenarios but arrives at one sure thing: "The need for government officials to shape their actions to support a high degree of investor attractiveness by reducing today’s undue policy instability and building a post-conservatorship GSE "business model" is seemingly bipartisan: Both the Republicans and the Democrats need to keep this goal front and center when it comes to their policy choices if they want the GSEs to become fully capitalized in some reasonable timeframe as part of exiting conservatorship."

Layton's summary can be found here on the Joint Center for Housing Studies website. Or read his paper in full, here.