What Would a Fannie/Freddie Conservatorship Look Like?

[Updated 9.8.08. Since I wrote this post, federal law has changed, as a banking law practitioner was kind enough to point out to me. Section 1367 of the Housing and Economic Recovery Act of 2008, Pub. L. 110-289, which became law on July 30, 2008, changes the GSE conservatorship provisions to ones that very closely track the bank conservatorship provisions of the Federal Deposit Insurance Act. In light of these (very needed) changes, the concerns I expressed in the post are no longer an issue.]

One of the possible rescue options for Fannie Mae and Freddie Mac is a conservatorship.  But what would this look like?  The New York Times relates that "Officials said that [Treasury Secretary] Paulson wanted to convey the message that...a conservator would have to prepare a plan to restore the company to financial health, much like a company in Chapter 11 bankruptcy proceedings." 

That's the general idea, but the devil is very much in the details, as explained below the break.

Chapter 11 is a detailed set of statutory provisions that build on general Bankruptcy Code provisions and an enormous body of caselaw. Moreover, there is a large and experienced Chapter 11 bar, and specialized government representatives (United States Trustees) monitoring the integrity of the process, and bankruptcy judges overseeing, and to some degree managing, the process.  This legal infrastructure has also created market confidence in the ability of the Chapter 11 process to fix struggling businesses.  Not every business can be saved, but for those with a chance, Chapter 11 works pretty well, and investors are willing to invest in the reorganization process (through bankruptcy claims trading and DIP financing and exit financing). 

That rich legal fabric of law, institutions, and personnel, and hence market confidence, is missing from a potential Fannie/Freddie conservatorship.  There only thing to guide a GSE conservatorship (beyond general conservatorship law and principles, which may or may not be applicable) is a fairly barebones section of the US Code, 12 U.S.C. section 4620.  It gives the conservator (which could be pretty much anyone, including a government agency) some avoiding powers (although more limited than a trustee in bankruptcy), prevents the operation of ipso facto clauses against the GSE in conservatorship, and creates a possibility (but not a requirement) of a 45 day stay of actions against the GSE.  The 45 day stay is the real key because it provides a window for a workout to occur.  But is it sufficient?

The 45 day stay contrasts to the bankruptcy automatic stay, which continues until the end of the case unless lifted for cause.  The 45 day stay appears to be modeled upon the stay for FDIC conservatorships, 12 U.S.C. 1821(d)(12). But the FDIC is in the business of doing bank conservatorships and receiverships--it is experienced and set up for handling failed banks. OFHEO, Fannie and Freddie's regulator, is not, and the FDIC is not really set up to handle a failed GSE.  45 days is a good stretch of time for the FDIC to resolve a failed bank, in part because the FDIC can strongarm other banks into taking on assets and investments of the failed bank.  But 45 days might not be enough time for a Fannie or Freddie workout.  There no OFHEO conservatorship team or experience in handling failed GSEs.  And the conservatorship provisions do not permit DIP management (see 12 U.S.C. 4619(a)(4)(B)(i)).  And the scale of Fannie and Freddie is alone an obstacle.  To be sure, the Treasury Department would likely bring significant pressure to bear on parties to a workout, but that might not be sufficient (remember the Master Liquidity Enhancement Fund debacle last fall?). 

It seems to me that if a Fannie/Freddie conservatorship were to be viable, the stay would have to be extended.  On the other hand, if Fannie or Freddie went into conservatorship and couldn't reorganize within 45 days, it might be as good as dead.  Regardless, a major problem with the GSE conservatorship option is that it doesn't have the infrastructure to work like a Chapter 11 reorganization.  Although that arguably gives the conservator a freer hand, it also reduces market confidence in the ability of a conservatorship to set a faltering GSE back upright.  And without faith in the ability of a GSE to reorganize, the reorganization is unlikely to succeed.  

Comments

[Mike Dillon]

I know it's still early in this soap opera but I'm curious to see if the heads of Messrs. Mudd and Syron will be separated from the bodies of Fannie and/or Freddie or if the finger pointing will turn back in the directions of Franklin Raines, Gregory Parseghian, and/or Leland Brendsel as scapegoats.

I, for one, am sick of hearing the phrase "without admitting any wrongdoing" associated with any corporate settlement - but ESPECIALLY in any legal actions having to do with the mortgage industry. If accountability and prosecution were the norms in the industry, instead of the extreme exception, there is an outside chance that the United States would not find itself in the current "foreclosure crisis" that it does.

In order to attempt to make this post relevant to the topic I submit Superior Bank FSB as proof that accountability and prosecution would have been far more productive tools in the long run than an FDIC receivership. The FDIC, if I remember correctly, took nearly 10 YEARS to examine Superior Bank before taking over. This happened in 2001, so FDIC scrutiny would have been taking place during Penny Pritzker's tenure as bank chair. (And she may be within spitting distance of the U.S. Treasury if Sen. Obama is elected?!?!?)

Part of the problem with the Superior regulation - or lack thereof - was a turf war that was taking place between the FDIC and the OTS. If I remember correctly, the FDIC refused to allow the OTS to get involved in the examination of Superior for something like 8 years. More than enough time for the Pritzker family to loot it and get their political ducks aligned. The family even cut a deal for the FAMILY (as opposed to Superior Bank/the 1400 depositors out $50 million) to receive 25% of any settlement between the FDIC and Ernst & Young for IT'S involvement in the fleecing of Superior.

If criminal charges are a possibility anywhere in the Fannie/Freddie debacle then they absolutely should be brought. There ought be some fancy charges that can be brought for submerging entire sectors of a national economy due to little things like greed.

Mr. Gekko may have been correct - Greed may, in fact, be good. However, in order for greed to truly work, the checks and balances (accountability/prosecution) need to work also. Because when the checks and balances don't work, and are ignored for significant periods of time, you get what we have today.

[AMC]

Everybody gets a fed bailout - except homeowners. No ability to restructure 1st mortgages in Chapter 13 for YOU!

http://www.washingtonpost.com/wp-dyn/content/article/2008/07/13/AR2008071301512.html?hpid=topnews

Treasury Takes Steps to Bolster Fannie Mae, Freddie Mac

By Neil Irwin and Jeffrey H. Birnbaum
Washington Post Staff Writers
Sunday, July 13, 2008; 6:30 PM

The Treasury Department took major new steps yesterday to bolster troubled housing finance companies Fannie Mae and Freddie Mac, making plans to increase the amount they can borrow from the government and enabling the government to directly invest in the firms if conditions worsen.

Treasury officials said last night that they may seek new authority to make government money available to the companies and that congressional leaders expect to be able to pass the new laws by the end of the week. It amounts to a more explicit federal backing of the quasi-government companies than has ever existed before.

The Federal Reserve also said last night that it is opening its emergency lending window to District-based Fannie Mae and Freddie Mac of McLean. The two firms, if they experience a cash crunch, will now be able to post safe securities at the discount window in exchange for cash, a privilege long held by banks and in the past three months enjoyed by investment banks, too.

The first step would expand the amount that Fannie Mae and Freddie Mac could borrow from the government in the event of short-term cash flow problems. Currently, they can each withdraw $2.25 billion. The Treasury secretary would be able to increase that amount at his discretion under the proposed law.

[lmclark]

In an earlier post, I suggested that private equity firms might prop up Fannie and Freddie if they just got a clear "red light" on conservatorship from Treasury and the Fed. Now it looks like they got it -- with Treasury seeking authority to buy stock in the two entities. A conservatorship looks less likely when the government, as a stockholder, would also be wiped out. So will private equity flock to Fannie and Freddie now?

[Patches]

Along AMCs' lines; Sup wit dat? Why is it that we have to throw more money at these huge companies but "John Q" only gets a token? When we first started what we have here as "Pass Thru" Mortgages in Chapter 13 BK, lawyers for Freddie and Fannie where there stating that "their" clients would not stand for the type of payouts and control that the BK court would exercise under the scenario. The scenario is that the payments on regular monthly mortgage payments if there was a claim for a mortgage arrearage would pass from the debtors paycheck thru the 13 Trustees' hands to the Mortgage Co or servicer. They almost hated the idea. I guess because of the extra set of accounting eyes or the likelihood of being called on late fees and similar charges...??

Families are going under and the government although presented with a viable and relatively inexpensive solution (13 BKs & Mortgage Modifying) will not entertain the idea. They are quick to react to Bear Sterns, IndyMac, etc... The governments’ solution is to throw money to the top and let it trickle down. Its' not making it all the way down! It's time to get the money flowing from consumer to lender again not throwing money at the lender, hoping that it makes it way down to the consumer. Lenders have way too many liabilities now; it's going to eat up all of that new low interest money and there will be nothing left when it makes it down here where it’s needed most. Keep people in their homes, keep them working = happy consumers = more tax collections and consumption. Give people something to work for. Give back that American Dream. People in “survival” mode do not spend on big screen TVs’ they “clam” up and save which is not a bad move for them considering the circumstances. Saving though is a bit more complicated these days, due to inflation and stagnant wages.

[AMC]

How our country really works, it seems:

http://news.yahoo.com/s/politico/20080716/pl_politico/11781

Lisa Lerer
Wed Jul 16, 5:44 AM ET

If you want to know how Fannie Mae and Freddie Mac have survived scandal and crisis, consider this: Over the past decade, they have spent nearly $200 million on lobbying and campaign contributions.

But the political tentacles of the mortgage giants extend far beyond their checkbooks.

The two government-chartered companies run a highly sophisticated lobbying operation, with deep-pocketed lobbyists in Washington and scores of local Fannie- and Freddie-sponsored homeowner groups ready to pressure lawmakers back home.

They’ve stacked their payrolls with top Washington power brokers of all political stripes, including Republican John McCain’s presidential campaign manager, Rick Davis; Democrat Barack Obama’s original vice presidential vetter, Jim Johnson; and scores of others now working for the two rivals for the White House.

Fannie and Freddie’s aggressive political maneuvering has helped stave off increased regulation and preserve special benefits such as exemption from state and local income taxes and the ability to borrow at low rates.

When their stock prices took a dive last week, their government allies extended another helping hand with a plan for the Treasury Department, the Federal Reserve and, possibly, Congress to shore up the companies.
___________________________________________

Clearly, the mortgage debtors in this country should just shut the hell up. It's their own fault they are in this situation. They have failed - utterly - to make the political contributions which are the quid-pro-quo for any relief from the federal government. Accordingly, these mere citizens of a lesser god deserve to lose their home.

If you aren't going to help yourselves - with lobbiests and political contributions - don't expect the government to bail your ass out when you and the kids get your clothing and furniture thrown out on the sidewalk after a foreclosure.

There ain't no such thing as a free lunch, 'homeowner'.

Grow up and play by the rules. [/Sarcasm]