An administrative plan published by the Urban Institute on Tuesday proposes several steps the Federal Housing Finance Agency (FHFA) can take to spearhead GSE reform. The plan, suggested by Jim Millstein, CEO and founder of Millstein & Co., aims to circumvent stalling legislative reform and put the bulk of the power in the FHFA’s hands.
To begin, Millstein recommends that the FHFA amend preferred stock purchase agreements (PSPAs) and suspend payment of cash dividends on Treasury’s senior preferred stock. This, Millstein says, would ensure GSEs have the financial resources necessary to protect taxpayers against expected loss.
“Until Treasury is willing to amend the PSPAs,” Millstein said, “FHFA should suspend payment of cash dividends on Treasury’s senior preferred stock to ensure that the GSEs have the resources to build adequate levels of capital to protect taxpayers against loss on the GSE’s trillions of dollars of mortgage guarantees.”
Millstein next says that the FHFA should create new regulations that address structural problems as evidenced by Fannie Mae and Freddie Mac. Specifically, he proposes that mortgage guarantors be subject to strict activity, leverage, and return on equity limitations. He also suggests a more nuanced system of guaranteeing differing mortgage products and more explicit pricing and details on the government’s risk and cost in backing GSEs.
“Because the GSEs are private companies with public charters, there is an inherent conflict of interest between the GSEs’ obligation to promote access and affordability and the private market’s imperative to maximize shareholder value,” Millstein said.
Ultimately, Millstein suggests separating out each GSE’s assets to a new, wholly-owned subsidiary company.
“Because the GSEs are private companies with public charters, there is an inherent conflict of interest between the GSEs’ obligation to promote access and affordability and the private market’s imperative to maximize shareholder value.”
Jim Millstein, CEO, Millstein & Co.
“First, FHFA would cause each GSE to create a new wholly-owned subsidiary (Newco), transferring the assets of its mortgage guaranty business to Newco and having Newco assume the liabilities of each business,” Millstein said. “This could be done separately for the single-family and multifamily guarantee businesses. With this asset and liability transfer, Newco and the GSE would enter into a reinsurance contract, pursuant to which the GSE parent would ‘reinsure’ Newco against any loss on its outstanding and future mortgage guarantees in exchange for a portion of the subsidiary’s guaranty fees (a ‘reinsurance fee’).”
By doing this, Millstein said, Treasury could then require GSEs use those reinsurance fees to build up reserve funds to protect in case of loss.
“The reinsurance contract between the GSE and Newco would require Newco to use its portion of guaranty fees—after operating expenses and reserves—to build capital to absorb potential future losses on its mortgage guaranty liabilities,” Millstein said. “The actual level of capital to be retained over time would be consistent with risk-based capital regulations for the mortgage guaranty businesses to be developed by the FHFA under HERA.”
With this “corporate restructuring,” as Millstein calls it, the country would then have four well-funded insurers for the GSEs, as well as a mortgage insurance reserve fund that would step in before the U.S. Treasury.
“This would balance facilitating access and affordability with recapitalizing an undercapitalized system,” Millstein said, “tapping private investor demand for mortgage credit risk through the sale of the four Newcos’ equity to the public, and protecting taxpayers against future losses by building layers of new capital at the Newcos and MIF reserves at the GSEs. These administrative actions, consistent with HERA’s mandates, can charter a path to ending the longest-running conservatorships in American history without threatening the stability of the housing market or mortgage credit formation.”