Public Remarks as Prepared for Delivery

Dr. Mark A. Calabria 

Director, Federal Housing Finance Agency

The Brookings Institution

Living wills for housing government-sponsored enterprises: Implementation and impact

Tuesday, May 11, 2021

Thank you, Aaron, for that introduction and for inviting me to speak today.

Thank you to the Brookings Institution for hosting this important discussion. It is an honor to speak before these distinguished panelists.

When President Lyndon Johnson addressed this institution on its 50th Anniversary, he said that, “in field after field, reports and studies that emerged from Brookings [brought] about substantial changes in law and in practice.”

And he highlighted as especially important “the power to evaluate […] the power to say, about public policies or private choices, ‘This works. But this does not.’”

All this is as true today as it was 1966. Brookings continues to inform our most consequential policy debates. And careful evaluation and analysis continue to be critical for effective policymaking.

Careful analysis is especially important when the government makes preparations for a crisis. During the 2008 crisis, American families were hit hardest by the effects of market uncertainty around how the largest financial institutions could fail.

Advance planning allows government institutions to act predictably and transparently. This helps the public and markets make their own informed preparations.

That it is why FHFA just finalized a resolution planning rule for Fannie Mae and Freddie Mac. The rule is built on the foundation of resolution planning established by the 2010 Dodd-Frank Act.

Under Dodd-Frank, America’s biggest banks are required to create resolution plans, or living wills, in the event a bank experiences severe financial stress. Each bank’s plan clarifies how it could be placed into a receivership overseen by the FDIC or into bankruptcy and resolved without disrupting markets or relying on extraordinary government support.

When President Obama signed Dodd-Frank, he said “because of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes. There will be no more tax-funded bailouts – period. If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy.”

Years later, looking back on Dodd-Frank’s implementation, then-Brookings Distinguished Fellow Janet Yellen said about living wills, “enhancements in resolvability protect financial stability and help ensure that the shareholders and creditors of failing firms bear losses. These steps promote market discipline, as creditors […] demand prudent risk-taking, thereby limiting the too-big-to-fail problem.”

I could not agree more. And FHFA’s new resolution planning rule accomplishes the same thing for our nation’s biggest housing finance institutions.

The rule also implements FHFA’s statutory receivership requirements to prioritize protecting housing markets and the Enterprises’ missions ahead of their creditors.

Fannie Mae and Freddie Mac own or guarantee more than $6 trillion in single-family and multifamily mortgages – half the market. Taken together, these Enterprises are roughly equal in size to the top three largest banks in America combined. And they are bigger than the 4th through 15th biggest banks combined.

Yet while banks must operate with leverage around 10 to 1, the Enterprises have only recently reduced their leverage to 140 to 1. That is not enough capital for them to survive a housing downturn.

We recognize the Enterprises are not banks. But an orderly system for settling claims is just as critical to any financial institution as appropriate capital standards. And as we learned in 2008, inconsistencies in financial regulation across institutions can mask risk and fuel financial instability.

Ensuring the Enterprises have credible living wills comparable to the other largest financial institutions enhances the integrity of the entire post-Dodd-Frank orderly resolution system.

It also brings important clarity to housing finance about how FHFA’s receivership powers would work in a time of significant financial stress, as remote as such times can seem when home prices are rising.

And today’s housing market is booming. The pandemic drove a surge in demand into already tight housing supply. The supply of available homes for sale dropped 40 percent year-over-year, to almost half pre-pandemic levels. Mortgage rates fell to the lowest levels on record.

As a result, in 2020, house prices jumped more than 10 percent in every Census region, according to FHFA’s House Price Index. That is the biggest year-over-year increase in the history of our index.

All this added onto what was already the national housing market’s longest period of rising home prices without a downturn.

Fannie and Freddie supported this market in 2020, ensuring mortgage credit stayed available despite the pandemic’s disruptions. They acquired more than 60 percent of the single-family mortgages originated last year.

But the cyclical history of the housing market teaches that strong house price growth is not a guarantee of future stability.

In fact, FHFA’s data shows that high prices gave Enterprise borrowers a slightly greater share of home equity in December 2005, on the cusp of the last crash, than they had as of December 2020.

We know that just as prices go up, they also go down. It is prudent to prepare for the downturns during the boom times. That is what FHFA’s resolution planning rule helps accomplish.

Several commenters on the rule suggested that planning for a safe and orderly resolution process is a bad idea because an Enterprise going into receivership is an undesirable policy outcome.

FHFA is committed to doing everything in our legal power to avoid an unnecessary receivership. That is why FHFA has been working to strengthen the Enterprises’ financial conditions and build their capital. The surest path to avoiding Enterprise receiverships runs through a capital raise securing enough equity to keep Fannie and Freddie solvent through a downturn.

But we also recognize that we have to be ready. The job of a prudential regulator is to hope for the best but prepare for the worst.

The Safety and Soundness Act sets out 12 conditions that can initiate an Enterprise receivership. The Act sets two conditions that trigger mandatory receivership.

FHFA’s rule implements the receivership authorities Congress gave the Agency in 2008 in order to make clear how they would work. This enables an orderly resolution process that protects Fannie and Freddie’s mission.

FHFA’s new rule requires each Enterprise to develop plans to facilitate their rapid and orderly resolution without disrupting housing finance markets.

Resolution does not mean dissolution. By law, Fannie or Freddie wouldn’t be going away.

FHFA must set up a new company that succeeds to the congressional charter to be Fannie Mae or Freddie Mac. The new, clean Fannie or Freddie would continue operating and fulfilling its mission.

These plans will be designed to protect the mission of the Enterprise throughout the restructuring process of any receivership.

Therefore FHFA’s resolution rule requires the Enterprises to develop their plans under the assumption of stressed economic conditions and without the expectation of extraordinary government support. These are customary assumptions in the resolution planning process established under Dodd-Frank.

The planning process starts with each Enterprise identifying its core business lines. These are operations critical to the stability of housing finance markets or fulfilling the Enterprise’s statutory mission.

The Enterprise must describe how these core business lines can be transferred and operated without interruption. The Enterprise must also identify potential obstacles to rapid and orderly resolution and steps to overcome those obstacles.

These plans will be essential to helping FHFA make key decisions in the event an Enterprise is placed in receivership. Those decisions involve transferring the core business lines into the new operating entity in a manner that creates franchise value and positive net worth, making it more likely to attract private capital and liquidity. 

Once the new entity builds enough capital, it will exit to permanent, independent status. The charters do not change. The new company will continue to be responsible for all its same duties and mission obligations.

The assets remaining in the failed company would be used to pay creditors. FHFA will minimize losses to the extent possible and pay creditors according to the prioritization set out by the Safety and Soundness Act. The law is very clear that creditors should expect to bear losses. The government’s priority is protecting the housing market as a whole and the missions of the Enterprises.

As important as these plans are, they must be backed up by the capability to execute an orderly resolution process.

Last year, FHFA hired Jason Cave from the FDIC to run our Division of Resolutions. We also just hired FDIC veteran Marc Steckel as Associate Director for the Office of Receivership Management, Governance, and Operations.

Jason and Marc were both key figures in FDIC’s implementation of Dodd-Frank’s Orderly Liquidation Authority. And they helped oversee the creation of credible living wills for America’s largest banks.

We are continuing to strengthen and grow FHFA as a world-class regulator.

We also continue to strengthen the Enterprises. In fact, today I think we see the strongest board and management teams in the history of these companies.

At FHFA’s direction, those teams are working on risk management and other supervisory concerns to ensure their business is conducted responsibly. And they are currently building capital by retaining their earnings.

Capital is essential for the Enterprises to fulfill their missions to promote mortgage credit access nationwide, expand affordable housing in underserved communities, and backstop the housing market in a crisis when other credit disappears.

When house prices are stable or rising, more capital at the Enterprises means more resources to support affordable housing and provide relief to families in need.

For example, when COVID hit, the Enterprises used their recently authorized retained earnings to help millions stay safe in their homes. And most recently, FHFA announced a new refinancing option that will help low-income families save thousands of dollars on their mortgage.

Capital becomes even more important in a downturn. When house prices decline, capital absorbs Enterprise losses and allows them to continue fulfilling their missions, providing stability and liquidity to the housing market when they are needed most.

In a crisis, capital at the Enterprises offers borrowers protection from foreclosure, destroyed credit, and displacement. This is especially important for lower-income and minority families who are often first to lose their jobs and savings.

That is why FHFA is making sure that Enterprise risk is matched to their capital. And it is why I have spent the last two years making every effort to build capital at Fannie Mae and Freddie Mac.

When I came into office, the Enterprises were allowed to hold only $6 billion in loss-absorbing capital to back their $6 trillion balance sheets. In September 2019, Treasury and FHFA raised their combined capital caps to $45 billion.

That change saved Fannie and Freddie from failing last year when the COVID shock hit. But it does not mean they are safe. In their current condition, Fannie and Freddie will fail in a downturn in house prices.

The PSPA amendments that FHFA and Treasury announced earlier this year were aimed at preventing that from happening. And they make some important progress toward that goal.

They effectively end the net worth sweep. This allows Fannie and Freddie to build capital to meet the requirements set out in the capital rule that FHFA finalized last fall.

But most of the work to put Fannie and Freddie in a safe and sound condition remains ahead. Allowing the Enterprises to retain capital is not the same as the Enterprises having capital. And building capital is not the only necessary step.

To responsibly exit their conservatorships, Fannie and Freddie must be both well-capitalized and well-regulated.

The resolution planning rule is the next critical component of FHFA’s commitment to protecting the mission of the Enterprises and the millions of families who depend on a stable mortgage market. Credible living wills provide the clear rules of the road needed in times of stress when large financial institutions can fail.

As President Johnson closed his Brookings 50th Anniversary remarks, he said, “When governments are faced with great public dilemmas, they must shape their programs with the greatest wisdom that they possess, but governments must act.” 

Credible living wills at Fannie and Freddie will ensure that, in a great public dilemma involving housing finance, FHFA will be able to act quickly without exposing the financial system or taxpayers to additional risk.

They will help FHFA act to protect the Enterprises’ mission even in the worst conditions. They build on the foundation laid by Dodd-Frank to end Too Big to Fail and protect taxpayers from Wall Street’s losses.

With this living wills rule, FHFA is preparing an important tool for a world-class financial regulator to hold in case of a crisis. But the surest path to avoiding Enterprise receiverships runs through raising enough capital to keep Fannie and Freddie strong through a downturn.

And FHFA will continue preparing the Enterprises to fulfill their mission throughout the cycle.