Regulatory Arbitrage Infinity! Law Limiting CEO Pay To $600,000 At Fannie and Freddie Easily Skirted Since Presidents Are Not Subject To Law

US Senator Elizabeth Warren probably thinks that the T-Rexs and Raptors in Jurassic Park can be regulated or contained. Just like she thinks that G-SIBS can be regulated without causing harm to the economy. But life finds a way.

Quicken Loans (and Rocket Mortgage) are examples of financial institutions that escape  regulation by remaining a privatley-held corporations. But there are zads of ways to avoid regulations imposed on  financial institutions.

Massachusetts Sen. Elizabeth Warren wants to make sure top executives at mortgage giants Fannie Mae and Freddie Mac are not being paid more than a congressionally-mandated salary cap allows.

An example of bypassing the regulatory swamp? Regulations prohibit Fannie Mae and Freddie Mac CEOs from making more than $600,000 per year. 

In a recently unveiled proposal – called the Respect the Caps Act – Warren is looking to close a loophole both agencies are said to be taking advantage of in order to pay their top executives millions.

Warren’s legislation was developed in response to a watchdog report from the Federal Housing Finance Agency’s (FHFA) Inspector General. According to the report, the FHFA – which oversees Fannie and Freddie – approved plans that circumvented the congressionally-mandated salary cap at the two agencies, which is set at $600,000. This was said to be done by separating the CEO and president roles, transferring tasks from the CEO to the president, and raising the president’s pay. Presidents are not subject to the pay cap.

As a result, two executives at Fannie were said to be paid $4.2 million to perform the same tasks a CEO has performed for $600,000. At Freddie, the figure was $3.85 million.

“Following the financial crisis, Congress passed my bipartisan bill to cap pay raises for executives at Fannie Mae and Freddie Mac. Instead of enforcing the law, the FHFA has allowed executive compensation at Fannie to increase by $3.6 million and at Freddie, by $3.25 million,” Warren said in a press release.

If the director of the Federal Housing Finance Agency – a post that Mark Calabria was just confirmed to – were to approve salaries that exceeded the $600,000 cap, he could be removed according to the terms of the bill.

The cap was put in place in 2015 after the former FHFA director sought to allow executives to receive a hefty, multimillion dollar pay package.

The former FHFA diector was … Mel Watt/

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Fixing The Holes? G-SIB House Hearing For CEOs Of Citi, Wells, BofA, Goldman, MS, JPMC, Etc. But Where Are Fannie Mae And Freddie Mac?

Today’s hearing in the US House of Representatives Financial Services Committee (where the committee calls Globally-Systemically Important Bank (G-SIB) CEOs to testify and ask them uncomfortable questions).

But today’s hearing should have been extended to mortgage giants Fannie Mae and Freddie Mac that unquestionably qualify as Systemically Important Financial Institutions (SIFIs), both under the statutory and FSOC definitions, and in any objective assessment of their financial importance. Are they G-SIBs? Of course.

Fannie Mae and Freddie Mac are supposed to maintain capital. Congress, in enacting the Safety and Soundness Act in 1992, established minimum capital requirements for the Enterprises and those standards have been in place for the past 25+ years. That Act requires the Enterprises to maintain minimum capital that is greater than or equal to:

  • 2.5 percent of on-balance sheet assets, which include mortgage-backed securities (MBS), mortgage loans, and other investments the Enterprises hold in their respective investment portfolios;
  • 0.45 percent of the unpaid principal balance of outstanding MBS not included in on- balance sheet assets, which include MBS the Enterprises issue and guarantee, but do not own and hold in their investment portfolios; and
  • 0.45 percent of “other off-balance sheet obligations.”

Well, the required capital for Fannie Mae and Freddie Mac clearly did not protect their shareholders from a catastrophic failure in 2008 due to declining home prices and a surge in mortgage delinquencies.

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In fairness, Fannie and Freddie are not depository institutions. But the sheer size of their loan portolios is worrisome.

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Whether you want to call Fannie and Freddie SIFIs or G-SIBs, they should have been called to testify as well.

Regulation of G-SIBs

Under the Dodd-Frank Act, all depository institutions with more than $10 billion in assets, including the U.S. G-SIBs, are supervised by the Consumer Financial Protection Bureau for compliance with consumer financial protection laws and regulations. Furthermore, the Dodd-Frank Act subjects the largest banks, including the U.S. G-SIBs, to heightened oversight and enhanced prudential standards to safeguard the U.S. financial system, which are implemented by the Federal Reserve. These requirements include enhanced capital, liquidity and leverage requirements, as well as regular stress testing to ensure banks hold enough capital to survive a future economic downturn or financial crisis. The G-SIBs are also required to submit resolution plans (also referred to as “living wills”) to ensure their firms can be resolved in an orderly way if they were to fail.

There have been several deregulatory developments and proposals in recent years. For example, S.2155, which was signed into law in May 2018 (Public Law 115-174), reduces the frequency of G-SIB stress tests, and it reduces other capital and leverage requirements. In addition, regulators have been advancing their own proposals. In April 2018, the Federal Reserve issued a set of proposals to simplify its capital rules for G-SIBs and introduced a “stress capital buffer,” or SCB, which would in part integrate the forward-looking stress test results with the Board’s non-stress capital requirements. The Federal Reserve joined the OCC in releasing a second proposal to substantially revise the current enhanced supplementary leverage ratio (eSLR) that applies to G-SIBs. After the proposal was released, former FDIC Chairman Martin Gruenberg said, “Strengthening leverage capital requirements for the largest, most systemically important banks in the United States was among the most important post crisis reforms…the amount of tier 1 capital required under the proposed eSLR standard across the lead IDI subsidiaries would be approximately $121 billion less than what is required under the current eSLR standard to be considered well-capitalized” (emphasis added). In response to a request from Committee staff for more information, the FDIC estimated the eSLR proposal would lower capital requirements for the primary federally-insured bank subsidiary of each G-SIB as follows:

● JPMorgan Chase & Co.: $34.597 billion (20.83% reduction in tier 1 capital) ● Citigroup: $26.978 billion (23.3% reduction)
● Bank of America: $22.838 billion (18.5% reduction)
● Wells Fargo: $20.406 billion (16.9% reduction)
● Bank of New York Mellon: $5.911 billion (33.65% reduction)

● State Street: $5.346 billion (37.5% reduction)
● Morgan Stanley: $2.507 billion (25% reduction)
● Goldman Sachs: $1.93 billion (9.49% reduction)

Despite proposing to reduce capital for the G-SIBs, the Federal Reserve’s own research has indicated current capital requirements are on the lower end of requirements that best balances benefits associated with mitigating systemic risk with a bank’s funding costs. Furthermore, the Federal Reserve has also been working on making stress testing more transparent to banks, potentially undermining the value of the regular exercise. Bank regulators have also proposed reducing enhanced prudential standards and liquidity requirements for banks as large as $700 billion, and there have been reports that regulators may reconsider their proposal on the Volcker Rule and propose further rollbacks of Dodd-Frank reforms.

Finally, while the Dodd-Frank Act and related reforms required additional capital and strengthened oversight of G-SIBs through the creation of the Consumer Bureau, there remain concerns regarding whether some of these institutions are adequately being held accountable for repeated consumer violations, and whether these firms may be too big to manage, as was discussed at the Committee’s hearing on March 12, 2019, with Wells Fargo’s former CEO, Tim Sloan.

Fannie Mae and Freddie Mac’s regulator is proposing that the mortgage-finance giants have a combined capital buffer of as much as $180.9 billion should the companies be released from government control.

I would really like to hear what new-minted FHFA Director Mark Calabria has to say on capital requirements and administrative reform.  And turning Fannie and Freddie loose again in the financial system.

Hopefully Calabria will be fixing the holes in the mortgage system.

 

Chasing Mavericks! Fannie Mae And Freddie Mac Are Chasing The Fed’s Asset Bubble (And Other Market Distortions) With Weaker Credit Standards

US home prices have escalated rapidly since The Federal Reserve began their zero-interest rate policies and asset purchases back in 2008.

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In order to serve their US homebuyers, both Fannie Mae and Freddie Mac have had to “soften” their standards for purchasing loans from lenders. Particularly since wage growth is slower than home price growth. And has been since 2012.

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For example, the mean Loan-to-Value ratio for Fannie and Freddie are higher than during the peak of the housing bubble … which blew up.

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In terms of Combined Loan-to-Value Ratio (CLTV),  Fannie Mae purchased loans have a higher CLTV than during the peak of the housing bubble.ffcltv

In terms of average credit score, both Fannie and Freddie tighted their loan purchase standards after the financial crisis, but has been gradually lowering them since 2012.

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In terms of debt-to-income ratios (DTI), both Fannie and Freddie now have average DTI at 2005 levels. We can call that “peak crisis” in terms of the house price bubble peak.

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Like Mavericks at Half Moon Bay in California, Fannie and Freddie are chasing Mavericksv (large waves) to serve the homebuying community.

To be fair, much of the elevated home prices are in coastal California where the tech industry has flourished and buildable sites are constrainted by zoning and other regulations.

*I want to thank my GMU finance students taking my Python for finance class. And downloading the Fannie and Freddie data and analysis in Python. These ambitious students include Fabiola Gonzalez, Fabiola Maldonado, Brandon Wynes, Nathan Handy, Eleri Burnett, Jessica Giron, Lisbeth Figuroa, Ulises Areas, Sarah Madi,
James Pesquera, Belinda Chambika, Alex Dilorenzo, Alexandria White, Steve Bergquist, Dudley Hinote, Amir Sayyad, Claudia Aguilar, Sabrina Hannan, Wael Ronnie Zaineldeen, and Peter Rogers. Thanks to Stuart Sanders and Hakin Azoor!