In the battle between Mel Watt, the director of the Federal Housing Finance Agency, and Treasury Secretary Steven Mnuchin over ending the so-called “Net Worth Sweep” (NWS) for Government-sponsored mortgage giants Fannie Mae and Freddie Mac, Watt has the law on his side.

As Infowars.com reported on May 11, Watt, in testimony given under oath before the Senate Committee on Banking, Housing, and Urban Affairs on Thursday morning, made clear his decision that Fannie Mae and Freddie Mac, the two Government Sponsored Entities (GSEs) he regulates, will end the NWS this month, at the end of the second quarter, to retain the earnings Fannie and Freddie need to rebuild capital.

A week later, on May 18, Mnuchin told the Senate Banking Committee he expects Freddie and Fannie to continue paying the NWS, even though Freddie and Fannie will hold zero surplus capital at the end of the year should the NWS continue that long.

Mnuchin told the Senate Banking Committee that he has had several discussions with Watt about Freddie and Fannie.

“I did tell him that it was our expectation at Treasury that they would pay us the dividend and we hope they continue to do so per the agreement,” Mnuchin said. 

Fannie and Freddie have paid back nearly $266 on the $188 billion the Treasury invested in the GSEs in 2008, completely repaying the principal and very close to repaying in full the 10 percent dividend the Obama administration had negotiated under the 2008 Senior Preferred Stock Purchase Agreements (PSPAs).

If the NWS continues, Watt testified by the end of the year Fannie and Freddie’s capital buffer will be zero, with the result neither GSE “will have the ability to weather any loss it experiences in any quarter without drawing further on taxpayer support.”

Watt made clear that under the authority given him as Fannie Freddie conservator under the Housing and Economic Reform Act of 2008 (HERA), he plans to begin retaining Fannie and Freddie earnings this quarter, effectively ending the NWS immediately.

Watt explained his goal was to rebuild capital within Fannie and Freddie, to avoid the need to ask Congress for additional capital should future quarters cause a capital crisis.

In response to a question asked by the Committee Chair Michael Crapo, Rep.-ID, Watt made clear as head of FHFA, he has the authority as GSE conservator to suspend the NWS on his own, without the approval of the secretary of the treasury.

Watt further specified he is willing to renegotiate the PSPA agreement to allow the GSEs to recapitalize, but he was opposed to the Treasury recapitalizing the GSEs by selling to the GSEs more preferred stock.

Watt made clear his decision as conservator to retain GSE earnings was not meant to institute a policy of “recapitalize and release” that would ensure the continued existence of Fannie and Freddie in the reform of housing finance that Congress anticipates addressing the near future.

Watt also made clear his opinion was the 30-year fixed-rate mortgage critical to first-time home purchasers would not continue to exist without a government guarantee.
The Housing and Economic Recovery Act of 2008 (HERA) not only created the FHFA to regulate Fannie and Freddie, but also gave the FHFA director the authority to end the conservatorship and discontinue the NSW, without seeking the prior approval of the president, the secretary of the Treasury, or the Congress.

Consider the following HERA provisions:

• Section 1313(a)(1)(A) establishes that among the principle directors of the FHFA director will be “to oversee the prudential operations” of Fannie and Freddie.
• Section 1313B(a)(5) further specifies this includes providing for “the adequacy and maintenance of liquidity and reserves.”
• Section 1313B(a)(11)(1)(B) further specifies this includes the obligation to specify a plan to restore capital if either Fannie or Freddie should be undercapitalized.
• HERA makes clear the primary responsibility of Fannie and Freddie are to maintain the orderly operation of private market funding and/or capital market access to home financing.
• Under HERA, the director of the FHFA is the conservator in situations, as now, when the continued operation of Fannie and/or Freddie requires a capital infusion from the U.S. Treasury.
• Under Section 1367(b)(2)(D), the director of FHFA acting as a conservator may take such action as required “to put the regulated entity in a sound and solvent condition” and “to carry on the business of the regulate entity and preserve and conserve the assets of the regulated entity.

The bottom line, is that Mel Watt, as the FHFA Director, can decide now – in the second quarter of 2017 – to end the NWS on his own authority.
In a speech that Watt delivered on Feb. 18, 2016, he made clear Fannie and Freddie could rebuild capital if the NWS were stopped.

“The remaining funds available under the Preferred Stock Purchase Agreements (PSPAs) provide the market with the assurance that the Enterprises can meet their guarantee obligations to investors in mortgage-backed securities even while they are in conservatorship and don’t have the ability to build capital,” Watt said.

Noting that by continuing the NWS, the funds Freddie and Fannie need to provide mortgage guarantees “can only go down and cannot be replenished.”

Clearly, by Mel Watt deciding to end the NWS now, when the PSPA principal and 10 percent dividend have been fully repaid to the Treasury, would give Fannie and Freddie an opportunity to replenish capital sufficiently, such that future infusions of government capital may not be needed.

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