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Investors: GSE reform starts by ending profit sweeps

Efforts to reform the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac and the U.S. housing-finance system will get a new look on Capitol Hill with the incoming Trump administration and Republican-dominated Congress. Tim Pagliara, founder of GSE shareholder-advocacy group Investors Unite spoke with Scotsman Guide News about where shareholders stand on the issue of GSE reform and its prospects under the Trump administration. Pagliara is a Tennessee-based investor as well as chairman and chief executive officer of the investment company CapWealth Advisors.

Do you think that Fannie and Freddie can be quickly reformed and released as private companies as Treasury secretary-designate Steve Mnuchin told Fox News in November?

PagliaraWell, absolutely. First, I think, HERA [the Housing and Economic Recovery Act of 2008] was really a GSE reform bill in and of itself. It allowed for the GSEs to be put into conservatorship under the Federal Housing Finance Agency (FHFA), and FHFA has done a really good job in reforming these entities. As Mnuchin identified, the biggest risk that they have right now is a lack of capital. This has been caused by the continuation of the net-worth sweeps [where all quarterly profits are distributed to the U.S. Treasury]. Under the statute, [FHFA is] required as conservator of the companies to return them to a safe and sound condition.

Privatization can mean many things. In what form do you think the GSEs can emerge from the conservatorship?

It can go any number of ways. The proponents of the sweep want to characterize investors as having a particular agenda as it relates to Fannie and Freddie. In my experience with Investors Unite, that is not the case. All that we have ever advocated for is that we want our rights to be respected in whatever scenario plays out. Shareholders should be treated according to the law, just like shareholders in any publicly traded company. There are a lot of different paths that could emerge under the term of "privatization" that would  uphold shareholder rights.

Where do you think Republicans in Congress and the Trump administration stand on this?

It was refreshing to see Treasury Secretary-nominee Mnuchin take such an aggressive stance on resolving the GSE issue. It has been eight years, and it is time for that. If there has been one thing that everyone has agreed upon with regard to the GSEs over the last several years is that the status quo is untenable. So, it is encouraging to see that we might finally get some movement. Ultimately, I think it is difficult to know how this administration will want to proceed. As we have discussed, there are a lot of viable paths toward privatization and the details are going to be hammered out by the legislators and the policymakers over the next several months. Again, our main concern is that, with whatever plan is formulated, that shareholder rights are respected  in accordance with the law. In the immediate term, it is in everybody’s best interest for the GSEs to build capital.

There are varying estimates of how much capital Fannie and Freddie would need to emerge as private entities, but it will be a lot. How do you think that obstacle will be overcome?

The first thing they need to do is end the net worth sweeps. It has always been dubious from a legal and constitutional standpoint. Now, it is actively and unnecessarily endangering taxpayers. The GSEs have paid back over $70 billion more than what they were loaned by the government. So, it was profitable.

It all comes down to respecting the rule of law. Virtually any discussion about privatization where you are trying to attract new capital, that is going to be real important to [potential investors] because they are not going to put new capital in, unless the rule of law is respected first.

The timing of this is very interesting because we’ve got two cases [in the federal courts challenging the legality of the profit sweeps] right now that are ripe. They could be decided and released any day — the Court of Appeals case from the D.C. [District of Columbia] Circuit and the U.S. Court of Claims case. Those could really be a big jump-start to these issues. 

Switching gears a bit, are Fannie and Freddie shareholders skeptical of the GSEs ongoing efforts to transfer risk to the private sector?

First off, I don’t think they are afraid of risk-sharing models. All financial institutions utilize techniques to manage risk in the course of their business. What we are afraid of is the type of risk-sharing models that they have forced on Fannie and Freddie. I did a conference call with the former chief financial officer of Fannie Mae, Tim Howard, and he broke all these things down. Essentially, what they have done so far with this mandated risk sharing is a bad political gamble for both the borrowers and the taxpayers.

So, the risk-sharing effort should be abandoned then?

Current practices should, absolutely. That being said, it is a nuanced question. Risk sharing is something that every business looks at, risk management. I just think the path that they are going down now is hurting borrowers. It serves no real-risk management purpose for Fannie and Freddie.

Do  you think GSE reform will get done within the next two years during this window of a unified federal government?

I don’t know when it will happen or what timeline, but I believe that this  administration will be more focused on an equitable application of the rule of law. That is what we have been focused on, and that is what we are excited about. Like I said earlier, there are a lot of variables. 


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