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GSE shares went down on senate proposal to "wind down" GSE. Politicians are enthusiastic to get their names behind "reforms" without clearly understanding the root cause and the option to fix the root cause. No surprise. Here is what Ralph Nader, Berkowitz and Ackman needs to do without wasting any time:
1. Why NO BIG BANG Reform is needed ?
- Publicly put the ROOT Cause for the 2008 Crisis - it seems like our politicians are suffering from amnesia. The point to prove is 2008 Downturn was a ONE-TIME event created by wrong incentives where players who wrote the Mortgage never bothered about Underwriting quality and these front-end mortgage salesman were happily satiating the demand of mortgages from so-called "investment banks"(eg: Bear sterns) . These "investment banks" could magically hold these Mortgages with less than 2% capital. Here is a frontline investigative story on that. Such a dramatic housing downturn event will NOT happen as reforms have been done to fix root cause. Investment banks don't exist and now they are all bank holding companies regulated with 10% capital ratio. As the GSE's post 2009 portfolio indicates, the underwriting quality has improved by leaps and bounds and the controls(loan-to-value ratio, credit worthiness check on the borrower, etc) taken by market players will ensure it remains that way.
- Articulate the minimal reform needed. Publicly prove by Sensitivity Analysis that "public utility model" is sufficient to ensure GSE will not only be profitable at all times in future but soon be well capitalized. By sensitivity analysis using 30 year home price fluctuations, 30 year delinquency and 30 year foreclosure rates prove that Government's role or capital would NOT be needed and the capital generated by GSE will be self-sufficient to endure the next trough in a future housing cycle downturn. Remember the post-2009 portfolio is historically the best quality portfolio that GSE's have had and also remember the multi-decade profitability of GSE (from 1986-2008 -link). Estimate the capital that GSE would have by 2018, if the Net Sweep agreement is revoked and the taxpayers get the 10% dividend. If at all capital is needed, indicate how equity capital could be raised by issuing preferred shares without damaging existing shareholders.
- Any unwarranted reform - Risky and may endanger the affordability of 30 year fixed rate mortgage instrument or the instrument itself. Without the regulated public utility model and the implicit Govt backing, the agency MBS would get expensive and the 30 year rate Fixed mortgage (the most unique thing in American housing market) will get expensive. Nobody knows how MBS investors around the world would perceive if the implicit Govt backing on Agency-backed MBS no longer exists.
2. What about the ownership rights of Shareholders in any restructuring ? It is very important for Ackman to articulate the equity value for Shareholders (Govt and Private) in the 'status quo' scenario that legitimately belongs to the Shareholders.
The Rule of Law in America AND the importance of Govt not changing rules midstream without consent from ALL stakeholders.
- The Supreme court will decide the Fairness/legitimacy of 2012 amendment a.k.a net sweep agreement at the time when GSE were already Profitable and they were in no dire straits to get capital. If they really needed capital, they could have approached the capital markets and gotten capital at much lower cost to shareholders than the draconian Aug 2012 agreement.
- Also, Ackman needs to point out that any Congressional reform on GSE that is NOT in the best interests of private shareholders and turnabout from the "quasi-govt/private" nature of GSE or the status quo will also be challenged in the Courts. Lets remember this is America (Not a banana republic) and Government can't whimsically change rules midstream.