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When Mick Mulvaney became acting director of the Consumer Financial Protection Bureau in November 2017, there was outrage over Trump installing a crony with designs on destroying the agency that defends people from financial ripoffs. The reaction was far more muted when Joseph Otting, former CEO of OneWest Bank and current head of the Office of the Comptroller of the Currency, began moonlighting as acting director of the Federal Housing Finance Agency (FHFA) earlier this month. But the appointment is just as dangerous to the future of everyday Americans, if not more so. After all, it concerns the largest financial asset most of us will ever purchase—our homes.
The FHFA oversees Fannie Mae and Freddie Mac, the two giants that purchase mortgages and package them into bonds to keep the market for homeownership liquid. Fannie and Freddie came under government conservatorship after the 2008 crisis, with the government accepting $187 billion in liabilities. That has all been paid back and then some in the decade-plus of government control. Despite the initial thought that conservatorship was a temporary solution, it’s now become something like a de facto nationalization.
Today, Fannie and Freddie purchase the lion's share of mortgages on the secondary market, and return all their profits to the U.S. Treasury. This standardization has enabled the government to wield a stronger hand in policing the market than the runaway irresponsibility of the housing bubble.
But some very rich and very powerful people don't like this situation—stockholders in Fannie and Freddie, mostly a collection of vulture hedge funds. They have fought on Capitol Hill and in the courts to force a re-privatization of Fannie and Freddie, so their profits can accrue to investors. Most of these hedge funds bought Fannie and Freddie stock at a bargain, and would win a major payday if the government ever spun them out.
Enter Joseph Otting, the brave knight who is trying to deliver the Holy Grail to the hedge-fund community. And it's already begun to pay off.
Otting, who led OneWest (with Steve Mnuchin as his chairman) as critics lambasted it as a foreclosure machine, took over for Mel Watt when his term expired on January 6. President Trump relied on the Federal Vacancies Reform Act, which gives presidents the ability to designate a formerly confirmed member of the executive branch as an acting officer of a federal agency. This was the subject of legal wrangling around Mulvaney’s appointment to CFPB, and Mulvaney eventually won out as the challengers to his appointment dropped their case.
But Otting's appointment is different. The Housing and Economic Recovery Act of 2008 (HERA), which gave the executive branch the legal authority to take Fannie and Freddie into conservatorship, is explicit in its rules around vacancies: one of three specific deputies within the FHFA organizational chart must serve as acting director until a successor is appointed.
Of course, those deputies have been aides to Mel Watt, who Obama appointed to the position. Because HERA provides that a president can only fire an FHFA director “for cause,” Trump was stuck with Watt throughout his first term. When his term expired, he clearly didn't want to wait around for his nominee for director—Mark Calabria, the chief economist to Vice President Mike Pence—to get Senate confirmation. So the Otting appointment was a rapid way to immediately change priorities at FHFA.
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Critics have spoken out about the Otting appointment’s weak legal footing. “There are really serious questions about its legality,” says Brianne Gorod of the Constitutional Accountability Center. “The statute quite clearly appears to limit the president’s authority.”
Though Otting has only been at FHFA for a few weeks, he has already made waves. The hedge fund managers desiring the privatization of Fannie and Freddie have sued the government, claiming that the FHFA is unconstitutional, because the president cannot fire the director unless it's for cause. Many bank regulatory agencies have this structure, including the CFPB and the Federal Deposit Insurance Corporation. But the hedge funders got a friendly three-judge panel on the Fifth Circuit Court of Appeals to agree with them, and rulethe FHFA’s for-cause provision unconstitutional.
The case has been appealed to the full Fifth Circuit for an en banc hearing. But Otting’s FHFA filed a brief with the court that it would no longer defend the constitutionality of that provision, a reversal of its previous stance. This leaves the FHFA with no defender in court against attempts to undermine its authority.
Otting subsequently told Politico that “a lot” could get done in his tenure at FHFA, and his top priority was ending the conservatorship. The White House proposed privatizing Fannie and Freddie last June, and Calabria also supports the idea. “Our goal is to be able to complete the release of [Fannie and Freddie] but at the same time make sure that it supports the U.S. housing market,” Otting said. Privately, Otting told FHFA employees that a plan to end the conservatorship would be announced in a matter of weeks.
This has set off shares of Fannie and Freddie like a rocket ship. The stocks are up over 170 percent this year, and dividend-bearing preferred shares are up 37 percent. Even if this plan, which would likely require Congressional sign-off, never materializes, Otting’s loose lips have provided a serious boost to hedge fund fortunes.
I'm not sure why markets believe that House Democrats would work with the Trump administration to overhaul the housing finance system and set up the same kind of private mortgage-backed securities market that failed so miserably in 2008.
A privatized Fannie and Freddie without oversight could exploit a government guarantee to take massive risks, grabbing profits while throwing any losses onto the taxpayers.
And homeowners could get caught in the crossfire, as they did in the crisis.
But one iteration of the privatization plan being floated would have the government sell warrants for common stock that could earn up to $125 billion. This would probably lose money over time, but the up-front injection of cash could prove attractive to those looking to reduce federal deficits. Of course, it would transfer enormous profits to hedge funds, who have used federal courts and lobbying muscle to try to pay off a big bet.
Of course, there's no actual plan yet. The Democratic leaders of the House and Senate banking committees, Representative Maxine Waters and Senator Sherrod Brown, wrote to Otting last Friday, demanding to see any plan for Fannie and Freddie’s future by February 1. “Your comments call into question the independence of the FHFA under your leadership,” Waters and Brown wrote.
In response to this, the White House slightly walked back Otting’s remarks, saying that “the administration will work with Congress to formulate a plan that fully addresses the risks to taxpayers presented by the current housing finance system and that improves the ability of creditworthy Americans to buy a home.” While this removed the threat of working unilaterally toward privatization, it still keeps alive the notion of pushing a plan through Congress.
Even if you believe that Fannie and Freddie should be spun out of the government—for the record I don't, I think effective nationalization has worked fairly well—there's no reason that hedge fund shareholders should be made rich in the process. Otting appears to be putting the financial interests of hedge funds over sound policy. And everyone with a home mortgage or wanting to purchase one has a stake in that decision.
