Will the GSEs Be Attractive Enough to Equity Investors for a Successful Recapitalization?
The two government-sponsored enterprises (GSEs) 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. In September 2019, the Trump administration began the process of ending the conservatorships and recapitalizing the two companies by “administrative means” – that is, without the need for 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. 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.
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. This capital will be produced by a combination of retained earnings (which could easily require a decade or more to build up if they alone provide the capital) and new equity issues. To put this amount of capital in perspective: the largest IPO in history of an American company in US securities markets 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, and possibly more than one for each GSE.
My paper “GSE Re-privatization: Will Washington Scare Off Private Capital?” explores whether the government’s plans and actions are consistent with making the two companies attractive enough to equity investors, and – given the need to raise such unprecedentedly large amounts of equity – to do so globally and broadly. The paper begins by explaining what the companies today represent as an investment opportunity, which is fundamentally different from what existed prior to conservatorship. Then the paper examines four issues where the government – in the form of FHFA, Treasury, or Congress – is already acting or has a real risk of acting contrary to this need for the GSEs to be strongly attractive to equity investors. These are examples of a level of government policy instability with respect to the GSEs that is much higher than investors have from owning the equities of other companies, whether they be large financial institutions, regulated public utilities, or other mortgage-market companies. If this policy instability is not significantly reduced over the next few years or, even worse, if enough investor-unfriendly decisions and actions pile on top of each other as the modus operandi of the post-conservatorship GSEs is built, then it is going to be almost impossible to raise the record amounts needed, except of course via retained earnings.
Unfortunately, I have found that most people who play a key role in housing finance activities generally have a “build it and they will come” attitude about raising the required capital; they assume record-setting amounts will somehow just show up when needed. However, the reality is that if “it” is not built right, they will absolutely not come.
Additionally, depending on the outcome of next week’s elections, it is possible the Trump administration’s GSE reform plan will be stopped in quick order by an incoming Biden administration via its immediate control of Treasury after the inauguration. If the Biden administration later were to choose a particular exit and recapitalization path, there is also a good chance that the requirement for raising such large amounts of equity would be part of it.
Thus, there is a bipartisan need for government officials to shape their actions to support a high degree of GSE investor attractiveness by reducing today’s undue policy instability and building a post-conservatorship GSE business model designed to support private-market ownership. Both 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 a reasonable timeframe as part of exiting conservatorship to become as normal as a GSE could ever be.