Budget Reconciliation, Fiscal Credibility & GSE Release
- R. Christopher Whalen
- 9 hours ago
- 7 min read
April 25, 2025 | Bank earnings are a decidedly mixed bag, with some banks showing falling credit costs while others see credit expenses rise sharply. US housing sales have stalled, a reaction that followed the MBS spread widening over Treasury debt we’ve seen in Q1 2025. In the latest edition of Inside Mortgage Finance, 30-year fixed mortgage rates have climbed back to almost 7% annual percentage rate (APR). Why have spreads widened? Two words: Uncertainty volatility.
The IRA was in Washington this week, visiting with mortgage peeps and our friends in the permanent government. In our next Premium Service note, we'll be diving into results from several bank and nonbank issuers. We have been getting a lot of great comments about the review copies of Inflated: Money, Debt and the American Dream. We are less than a month away from release by Wiley Global! Thank you to readers who have preordered.
Our trip to Washington this week was enlightening in both good and bad ways, but suffice to say that the city built on the muddy banks of the Potomac is focused on survival and, of course, personal enrichment. Survival is seen as a function of tax and spending cuts, combined with a manic effort to monetize the many, many moribund assets of the US Treasury, including Fannie Mae and Freddie Mac. And yes, if you are interested, the busted reverse mortgage book from the 2021 bankruptcy of Reverse Mortgage Trust is available.
The race to the midterm election is well underway, but President Trump hopes that shock and awe keeps progressives in the current state of confusion through next November. Democrats is some states are mounting a limited counter-offensive, but internecine rivalry between moderates and progressives seems more likely. Meanwhile the Trump budget package is priority number one on Capitol Hill, but odds of the big tax bill passing are falling every day. The White House still needs 25 votes in the House and May is upon us.
Jim Lucier at CapitalAlpha Partners advises that there is a placeholder for the House Financial Services Committee to find “savings,” but nothing specific as yet on the assumed value of a GSE release from conservatorship in a budget reconciliation. “That would properly be in the Finance title of the reconciliation tax bill that gets marked up on April 30,” he muses. “We could get a chairman's mark the day before, but I suspect that we won't see a chairman's mark until the day of.”
Members of Congress are not particularly worried about reading legislation before the vote so long as all of the numbers continue to go up. Whether the GSEs exit conservatorship is mostly a matter of indifference. Most MCs could not even explain the meaning of the term GSE. The good news of sorts is that the GSEs will indeed exit conservatorship -- if the Trump Administration uses the cash value to support a budget reconciliation.
The bad news is that the US will end up owning well-more than 95% of the equity upon release, including the crushing dilution of the private investors and also the Treasury’s own preferred position by the accumulating liquidity preference. Sorry hedge fund peeps, full dilution awaits common holders, no forgiveness. And for this reason, we think the Trump Administration will be forced to restructure the GSEs to unlock cash in the shortest period of time.
As we told a room full of very smart people yesterday, our preference for restructuring the GSEs will be for the Treasury to convert its option into common shares, then further issue new common shares to repay the liquidation preference as required by the same federal law that applied to GM, AIG and Citigroup. But unlike these commercial companies, the GSEs will never be truly free of control by the Treasury.
Selling common shares of Fannie Mae to the public was a fraud in 1968 and doing it again in the 2020s is also a fraud because the US retains dominion over the assets. As Supreme Court Justice Louis Brandeis wrote in 1925 regarding a fight over ownership of collateral in Benedict v Ratner, the question of control "rests not upon seeming ownership because of possession retained, but upon a lack of ownership because of dominion reserved. It does not raise a presumption of fraud. It imputes fraud conclusively because of the reservation of dominion inconsistent with the effective disposition of title and creation of a lien." But fortunately the Trump Administration has an opportunity to fix this conflict while also doing right by the private shareholders and without new legislation.
"I understand the technical part of saying government has controlled these entities since 2008," notes our friend Fred Feldkamp, who 50 years after Brandeis issued his harsh dictum found a way to perfect a true sale using the pathway blazed by Ginnie Mae in 1970. "Fairly read, however, the GSEs have ALWAYS been controlled by government. They could not exist from 1925 to 1973 without government control (guarantee of debt, express or implied), because the ability to sell bonds backed by private pools of residential mortgages was 'dead' for that period of time. Once they were 'socialized' (necessary to fund at low premiums) the 'Animal Farm' problem hit home."
For reasons we discuss below, we believe that if the Trump Administration needs to monetize the GSEs quickly, then the United States ought to remain the sole common shareholder of the two enterprises. Perhaps Fannie Mae and Freddie Mac could be consolidated into one GSE to operate alongside the Federal Home Loan Banks. The FHLBs buy loans from banks, perhaps one day from nonbanks as well. The GSEs will be securitization conduits and insurers of conventional loans. There is no point in having private common shareholders.
How does embracing an explicit public/private model help President Trump and Treasury Secretary Scott Bessent? First, by having a frank discussion of the credit reality of the GSEs, we can make the process of release credible and eliminate the conflict of having hedge funds speculate in GSE shares with impunity. The big goal is to make the transaction so credible that the Congress will find it difficult to meddle with the public GSE operations.
Second and more important, restructuring the capital of the GSEs will make the release process more credible fiscally, particularly with financial institutions and global investors, and raise a lot of money for the Treasury. Selling $500 billion in common shares to the public makes no sense in a market where investors want safe yield. Better to buy in the common shares down to say $50 billion and then let private capital fund the rest in senior preferred and debt.
Upon release, the GSEs should repurchase and extinguish common shares from the Treasury and finance this process with cash profits and issuance of new nonvoting senior preferred shares. The GSEs should also offer to repurchase shares in the open market, offering private investors the opportunity to exchange common for new senior nonvoting preferred on an attractive basis. Eventually, most of the GSEs capital structure will be senior preferred and debt held privately, while the Treasury could hold the remaining capital as common, essentially a "golden share." And the capital needs of the GSEs should be reduced accordingly, increasing resources to support housing.
Having the United States as the sole common shareholder is credible because ultimately the Treasury retains dominion over Fannie Mae and Freddie Mac, and can reassert direct control of the GSEs at any time. By keeping the US as the sole shareholder of the GSEs, we preserve the 30-year mortgage, rate locks for consumers and to-be-announced (TBA) market eligibility for conventional loans. Most important, keeping the US taxpayer as sole owner of the GSEs will avoid any need by Moody’s and other rating agencies to change the ratings of the issuers or visit the rating of the conventional MBS for the first time.
In terms of taxes, by restructuring the GSEs into public utilities, we can end the free-riding by private investors on the public credit. Retiring all publicly held GSE common shares and selling new senior preferred shares to the public provides a very credible way to raise hundreds of billions of dollars for the Treasury in a short period of time. Domestic and global investors would be lined up out the door for this new, big risk-free asset class.
By ending the games in GSE shares, the Trump Administration will make clear that the days of private investors profiting at public expense are over. We make Fannie Mae and Freddie Mac into true utilities with zero alpha to attract Pershing Square and other hedge funds. Sorry Bill. And by aggressively restructuring the balance sheets of the GSEs, we can give President Trump and Congress the cash needed to preserve the tax cuts and make other important changes to our fiscal house.
As Ed Pinto of American Enterprise Institute and Alex Pollock of the Mises Institute wrote in “Not Another Free Lunch” for Law & Liberty:
“The conventional narrative is that an exit from conservatorship would be a ‘privatization’ and Fannie and Freddie would again become “private” companies. It is not the case. To be a GSE means that you have private shareholders, but you also have a free government guarantee of your obligations. As long as Fannie and Freddie have that free government guarantee, they will not be private companies, even if private shareholders own them.”
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