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Sandra Thompson had her Senate Banking Committee hearing for her nomination to become director of the Federal Housing Finance Agency, which oversees Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC). Because of the terms of Treasury’s SPSPA, FHFA needs to work with Treasury to administratively end the conservatorships of Fannie and Freddie — but is really at the mercy of Treasury.

In her hearing Sandra Thompson was asked some direct questions about ending the conservatorships and at the start she said she would defer to Congress even though the senators posing the questions pointed out that the existing statute authorizes her to end the conservatorships without an act from Congress. At the end, however, Sandra Thompson reluctantly acknowledged that she could end the conservatorships without involving Congress. It would seem that the Senators asking these questions should have instead been asking Treasury’s Janet Yellen, because that’s the person whose signature is needed to end the conservatorships of Fannie and Freddie. To that end, the best Sandra Thompson can do is get Fannie and Freddie ready to exit conservatorship — and this hearing reveals her commitment to that.

Investment Thesis

Fannie and Freddie are retaining earnings after being put on a path to exit conservatorship by the prior administration. Despite having worked at FHFA for the past 8 years, Sandra Thompson had a difficult time admitting that Fannie and Freddie could exit conservatorship under existing legislation. I think that in a certain context, this makes sense. Specifically, Sandra Thompson is unable to end the conservatorships herself. The way the Senior Preferred Stock Purchase Agreements are structured, FHFA is at the mercy of Treasury should it want to pursue the end of the conservatorships. To that extent, Treasury has not yet taken additional steps yet to end the conservatorship and under the prior Housing Finance Reform plan, there are still outstanding legislative steps that could be taken to help facilitate reform. It is my understanding that the Biden administration wants to enact its own version of housing finance reform and it began by firing Mark Calabria. From there it quickly enacted specific, targeted reforms while getting a permanent FHFA director in place. I would expect that once FHFA has a permanent director, the Biden administration will revisit housing finance reform and push forward with raising capital to protect taxpayers and monetizing its equity stake. If the government chooses to monetize the liquidation preference of its senior preferred stock, commons are overvalued at these prices, and so I recommend owning preferred stock, which trades 8-13 cents on the dollar and would get at least par in a restructuring where it converts to common in order to moot/settle the litigation.

U.S. Government Accountability Office (GAO) January 2022 Report

The GAO has put out its January 2022 Housing Finance System report. The 2-page summary can be found here. In the report they point out that the current administration has not issued plans of its own for housing finance reform:

GAO Points out Treasury has not issued plans of its own for housing finance reform yet under Biden

GAO

The GAO recommended that Treasury should consider recommendations from the 2019 housing reform plans:

GAO recommends Treasury should review the 2019 Housing Finance Reform Blueprint

GAO

The Treasury wrote back (Appendix IV) saying that they accept the recommendation in the Draft Report:

Treasury agrees to accept the GAO recommendation

GAO

Three steps from this plan relate to Ending the Conservatorships:

2019 Housing Finance Reform Plan Steps To Ending The Conservatorships

Treasury

GAO Noted that Treasury’s 2019 reform plan option 20 and 22 was entirely complete and 21 was partially complete:

GAO provides status of 2019 Housing Finance reform plan status

GAO

Note that none of the legislative recommendations have been implemented:

The 2019 plans contained legislative and administrative recommendations, but only administrative recommendations have been implemented.

When the prior administration handed off housing reform to the Biden administration, Treasury supported legislative reform that authorizes an explicit, unlimited backstop for agency mortgage backed securities.

Sandra Thompson’s Senate Banking Confirmation Hearing

When I first watched this hearing, I was confused, but in transcribing this hearing, I think what has happened is that Crapo had a conversation with Thompson last week that had her saying she wants to work with Congress, so bear with me. I am only going to be quoting the conversations relevant to the restructuring of Fannie and Freddie

Senator Tillis from North Carolina had the following exchange with Sandra Thompson:

Tillis: Miss Thompson, can you provide more clarity about the prospect of FHFA eventually releasing Fannie Mae and Freddie Mac from conservatorship? Is there an anticipated time frame and are you concerned about any negative market impacts?

Thompson: Senator that’s a great question, certainly we would defer to congress on the exit from conservatorship for the GSEs. In the meantime there are a number of things we are doing. The enterprises are building capital. We are encouraging the Credit Risk Transfer program and we are establishing pricing so we are also supervising them in a safe and sound manner and making sure that they meet their mission so that whenever they exit from conservatorship, they will be ready. I’d also like to mention that there are a number of stakeholders that would likely need to be involved and engaged in a discussion before that ever happened. The Treasury, certainly, as the owner — the majority owner of the GSEs — and certainly going to make sure that the taxpayers are adequately compensated. We’d probably have conversations with the Fed and also the Justice Department on outstanding litigation, so just a number of steps that would have to take place before the enterprises would be able to exit conservatorship and they’d have to meet their capital targets which are quite vast.

Needless to say, this was absolutely frightening to hear as a shareholder of these companies where the law is clear that FHFA does not need congress to release Fannie and Freddie from conservatorship. You will see in the following exchange with Senator Hagerty that needing to defer to congress was not in line with his interpretation of the law either. I think what is happening here is that Sandra Thompson is not in a position to do anything on her own, and she has to defer to Treasury, and it sounds like Treasury is looking at possible legislation to best enact its version of housing reform.

That said, let’s look at what Hagerty’s exchange with Thompson was like. After Tillis came Senator Hagerty from Tennessee:

Hagerty: As director of the FHFA, you are meant to carry out the law, not to be a policy maker, the Housing and Economic Recovery Act does not permit indefinite conservatorships, by definition no conservatorship is meant to be permanent. My question to you: “Will you commit to do everything in your power to fulfilling your statutory mandate to end the conservatorships?”

Thompson: Certainly no one ever expected the enterprises or any financial institution to be in conservatorship for 13 years. We believe that congress has a role and we will be working to help in any way that we can facilitate any questions that you have but we think that this is something that congress needs to work on as well.

Hagerty: Is there any point in the law that says congress must approve an exit from conservatorship?

Thompson: I don’t know that they must approve an exit from conservatorship, but just in terms — there are a number of issues that congress will have to address, specifically if the enterprises exit conservatorship will the companies be private, will they be public, what form will they be in? There’s just a whole host of issues that would have to be considered that congress must weigh in on, but certainly FHFA can get the enterprises ready.

Hagerty: Acting director, if you are concerned that the HERA act does not provide adequate clarity, I hope that you will get back to me and my team in the areas that you see inadequacy in the legislation because it is my expectation that the legislation is clear and that an exit is called for.

Hagerty made it clear that Congress is not needed for FHFA to end the conservatorships of Fannie and Freddie. At this point, I was wondering if Sandra Thompson even knows what she is talking about. My interpretation of her commentary thus far was that deferring to congress means that she will defer to what the law says and this is her opportunity to get in front of active legislators and work on potential legislation to best resolve the conservatorships of Fannie and Freddie — a noble cause. This perspective began to grow roots when Senator Crapo came up next and pointed out earlier conversations about potential pending legislation.

After Hagerty, Senator Crapo made it sound like there was a back channel discussion regarding pending housing reform legislation being had between FHFA and his office:

Crapo: Let me start out with you director Thompson. First of all I very much appreciated our visit last Tuesday. I just had one quick question for you which we discussed then. Housing finance reform, which you know is a top priority of mine and it’s been my view that congress must find a pathway forward to resolve the conservatorship of our GSEs and do so expeditiously. In that context, I applaud Senator Toomey for releasing his housing finance reform principles last March which reflect many of the goals that I outlined when I was addressing this issue as the Chairman of the committee. These principles include establishing stronger levels of taxpayer protection, preserving the 30 year fixed rate mortgage, increasing competition among mortgage guarantors, ensuring a level playing field for lenders of all sizes and promoting access to affordable housing. My question to you is if confirmed as the FHFA director, would you be willing to support legislation that is consistent with these principles?

Thompson: Absolutely. Thank you senator.

Crapo: Nice brief answer, and the right answer — I appreciate it.

So, now things were making more sense. It sounds like Thompson is working on potential legislative reform in addition to her own versions of reform. Needless to say, her commentary so far was arguably confusing because of her insistence to defer to Congress which out of context doesn’t really make sense. Senator Toomey followed up with some more pointed questions to prove to the panel that Sandra Thompson did realize that she could end the conservatorships without Congress:

Toomey: It’s my view that HERA clearly does authorize the FHFA to take the GSEs out of conservatorship. Can you tell me specifically is there something that is lacking in legislation that you think is required for you to move in that direction?

Thompson: FHFA is going to have to have a conversation with Treasury. The end state of the enterprises is something that Congress would have to legislate. If the enterprises reach their capital requirements that we’ve established, we certainly would be having conversations with lots of different stakeholders, but the end state, if Congress wants the enterprises to come out as-is, then that I think is doable within the statute, but if there is another outcome — if they wanted to be a utility or if they want other charters — those are things that Congress is going to have to do.

Toomey: Well sure, if we wanted to change the existing statutes and change existing charters then we would have to pass legislation to do so, but my point is that’s not the only option available. Would you commit to going as far as you legally can in moving in the direction of coming out of conservatorship?

Thompson: I will commit to positioning the enterprises and working with the Congress to do whatever is necessary to move them out of conservatorship in a responsible time frame. We will certainly be wanting to work with Congress and other stakeholders on this issue.

As such, it is more of a preference of hers to work with Congress, and why not? After all, these are the people she needs to approve of her so that she can become permanent director of the FHFA, and it sounds like at least Crapo wants to pass pending legislation so she has to play the game to get into the seat.

Summary and Conclusion

This confirmation hearing was confusing to watch. It seemed like Sandra Thompson didn’t have a very good understanding of how the law worked, but once I unraveled all of the conversations, things began to make more sense. Sandra Thompson can’t end the conservatorships unilaterally. At the very least, she needs direction from Treasury about how to restructure Treasury’s Senior Preferred Stock Purchase Agreement liquidation preference. If this is converted to common/equitized then common are worth $0.10 or so. If this liquidation preference is written down in order to moot/settle pending litigation, the commons are worth $5-8.

As such, it would seem that these senators who were asking about ending the conservatorships true gripe is with the existing administration’s position on housing policy, which basically doesn’t officially exist yet. That said, Sandra Thompson has made progress reforming Fannie and Freddie and getting them ready to be in a position where Treasury can consider restructuring its equity stake absent any pending legislation.

So far, no legislation has been passed since HERA 2008. Sandra Thompson is committed to working with Congress to work on potential legislation that might help her end the conservatorships. That said, if Treasury, the Fed and the Justice Department figure out that there is $50-$150B of value in Treasury’s equity position in Fannie and Freddie and want access to that money and FHFA is done implementing its views of administrative reform and ready to work with Treasury to lock in Biden’s views of housing, Thompson acknowledges that Congress is not needed to end the conservatorships.

This past month, Treasury received the new GAO report and despite the 2019 plans being issued under a prior Administration, they accept the GAO recommendation as they continue to work with Congress and Treasury’s partners in the Administration on these issues.

I look forward to a quick confirmation of Sandra Thompson and next steps being taken down the path of housing finance reform. I expect that Sandra Thompson is confirmed and Fannie and Freddie continue to be prepared with rules that they can use to operate effectively post conservatorship. Then, I expect the Treasury to pursue locking in its views on housing finance reform and monetizing its equity position. If it acts quickly, it may be able to moot/settle pending litigation instead of getting stuck with a $30-50B bill payable by the taxpayer as shareholder litigation goes to trial this summer.



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