Mark Calabria (Former FHFA Director and Cato Senior Advisor) joins the podcast to discuss his tenure as director of the FHFA (Federal Housing Finance Agency), his legacy of creating a capital rule for the GSEs which remains in place, financial regulation in wake of the global financial crisis, as well as fiscal and monetary policy amid the recent surge in inflation following the COVID-19 pandemic.
Jon: “Welcome to the Capitalism and Freedom in the 21st Century podcast, where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Thanks so much for joining us today. Today our guest is Mark Calabria, he was a senior advisor at the Cato Institute and former director of the FHFA. Prior to that he was chief economist for Vice President Mike Pence, and prior to that was a long-time Senate banking staffer, working with Senator Richard Shelby and Senator Phil Graham. He's also the author of a new forthcoming book, Shelter for the Storm, which is coming out in the first quarter of 2023, which you can pre-order today at Amazon. Mark, thank you so much for joining us.”
Mark: “Jon, it's such a pleasure to be here.”
Jon: “Mark, first, I want to get into your background, and what first got you interested in economics and FINREG prior to your incredible and fascinating career in policy?”
Mark: “I think it really honestly goes all back to that change from undergrad to grad school. I finished my undergrad in the early 90s, when we first started talking about jobless recessions, and it was the aftermath of the savings and loan crisis, real estate problems in New England, Texas, other places. And so I really entered grad school at a time, A, because there was a weak job market, so grad school looked like a great thing to do, and I was certainly interested in economics in general, but also in that environment of really talking about the most recent crisis. And it's really something that has kind of kept with me during my entire career, is thinking about, you know, the stability of our financial system, the impact of property markets on financial stability. I ended up, most of my focus in grad school being on market structure and trust organizations, so I sort of have come to finance and economics more from a market structure perspective, more than anything else, but certainly have come to this from that shadow of the savings and loan crisis, having an impact not just in our country, but on my career choices and on my life choices.”
Jon: “Well, that's fascinating. I feel like there's a number of people in financial regulation and in sort of the monetary policy sphere who kind of have that industrial organization kind of background interest in how market microstructure works, you know, people like Darrell Duffy and others coming to mind. That's fascinating. So I'm curious, you know, moving straight into FHFA here, you know, what is the FHFA? If you could explain to our listeners and what's its role as a financial regulator? I know it came into being during the financial crisis when Fannie Mae and Freddie Mac were going into conservatorship, i.e., you know, they were troubled with all these mortgages, distressed mortgages on their balance sheets. And I remember then-Secretary of the Treasury Hank Paulson decided to put them into conservatorship. He fired the CEOs of these GSEs. And they effectively became—they were put on the balance sheet of the government. I know FHFA also has a seat on EPSOC, which is also a product of the global financial crisis. But could you get into that in terms of—“
Mark: “There's a lot there, Jon.”
Jon: “There's a lot there, but could you give us a sort of history of the FHFA and what its mandated role is and what it's been doing?”
Mark: “Happy to, and of course, this is the Federal Housing Finance Agency. It was created in 2008. Now, the history of this, you know, I've had the fortune not only of writing it at one point, but being the primary draft of the legislation that created it that eventually passed in 2008. But this really started, at least for me, in 2003 when the accounting scheme of Freddie Mac first came to light. And I was then working, again, on the Banking Committee for Senator Shelby. And we started working on a reform bill in 2004. And one of our takeaways—because it was almost really just shocking to think about just weeks before the accounting scandals of Freddie came to light, the then-regulator of FAO, the Office of Federal Housing Enterprise Oversight, had issued its annual report to Congress and had said glowing things about the accounting and the stability of Fannie and Freddie. And so it really kind of shocked us to really kind of look it in the face and say, there's really nobody watching. And again, I'm not going to take away anything from the hardworking people at FAO who tried to do the right thing. But in the early 2000s, the regulator really just did not have the regulatory, statutory tools it needed. It lacked many of the statutory tools that other financial regulators like FDIC had. And it was just politically outgunned. So our reform efforts began in 2003. There was a Shelby bill in 2004 and again in 2005. Partly because if you really—it's hard to imagine the headiness of the housing market in 2005, where the view was prices only go up and great wealth-making machine. And so there was a tremendous amount of pushback. I mean, at least today you can suggest that prices go down and there may be stability concerns in housing. In 2005, were you to suggest such as I did, you know, you were certainly looked at as an anomaly, if not crazy. So all that said, it was near impossible to get financial reform done on Fannie and Freddie in the years leading up to their failure. Even though many of us raised that alarm bell, you know, worked on legislation and tried to get it done. And then when the crisis hit, Congress had changed. At this point, Senator Dodd was chairman of the Banking Committee. Senator Shelby was the senior Republican, the ranking member. And so what actually happened was Senator Dodd had a number of proposals to deal with the housing market, one of which became Hope for Homeowners, and Senator Shelby's response was, you know, we're open to providing assistance to homeowners if you agree to have GSE reform as part of the package. Senator Dodd said yes, and so that's why we were able to get mostly what the Shelby bills, with a few tweaks, incorporated into what became the Housing Economic Recovery Act of 2008, which took OFEO, as well as the Federal Housing Finance Board, which was the regulator for the federal home loan banks, and merged them in. So starting in 2008, we had a new regulator for Fannie and Freddie, the federal home loan banks. As you touched upon, you know, Fannie and Freddie were looking like they were going to start failing in the summer of 2008. They were taken into conservatorship. You know, by then, FHFA had been put in place. Jim Lockhart, who was the last OFEO director and the first FHFA director, you know, worked with Paulson. They put them in the conservatorship. I really want to emphasize, you know, having worked on this, we framed the conservatorship provisions very much on those of the FDIC, but we never imagined it would go, nor did Congress ever intend for it to go more than six months. So the fact that, you know, we're over a decade, and it's post-2008, really is, to me, completely contrary to rational intent. But we are where we are. And part of this was, of course, the sense from Treasury, as well as others in Washington, about what concerns would happen, you know, in terms of the agency debt market. And we know this from both his books that he's written, in terms of Treasury Secretary Paulson, as well as other statements. For instance, he went to China immediately near therein. The Chinese were very large holders of Annie and Freddie securities. And, of course, we now know that there were attempts by Russia to get China to both dump their agency securities. So there was some concern, not just financial stability, but also foreign policy concerns around them. I'll say this on the side. You look at the congressional record, and it was very clear, Shelby and others mentioning, listen, we know China holds this debt, but so what? We're not here to bail them out. And so one of the things that's lost is that one of the intentions of HERA was not to harden the implied guarantee.”
Jon: “And can you explain what HERA is?”
Mark: “It's the Housing Economic Recovery Act that created FHFA. So the intent here was to actually end the implied guarantee. This is a bit of a weird topic because, of course, implied guarantee almost sounds like a contradiction of terms. So, over the decades since V&A Freddie's creation, there really had become a perception that because they had a government charter, that they were backed by Congress. Of course, there is no explosive guarantee. There's never been a guarantee provided by Congress. But, you know, the financial market participants, who, of course, held lots of agencies, and it's also important to keep in mind, the agency debt market, and Fannie Freddie debt market, is one of the biggest in the world. And, in fact, you know, in 2020, there were more agency Fannie and Freddie, along with Ginnie Mae Securities, issued than Treasuries. So, this is really one of the biggest fixed income markets in the world. A lot of our financial institutions, even with the failure of Fannie and Freddie, there were over a dozen small banks that failed from losses on preferred shares of Fannie and Freddie, and were, you know, the debt to take a loss, you would have certainly seen dozens of more banks fail. So, you have a situation where you have two extremely leveraged companies with their debt held throughout the financial system. And, of course, just as you later saw with Dodd-Frank, Title II of Dodd-Frank's Resolution Authority, there was a resolution authority created in 2008 for Fannie and Freddie where losses could be and should be imposed on creditors, but, of course, that was not the choice that was made. And so, you had them in conservatorship since then. The primary purpose of FHFA, of course, is to be a safety and soundness regulator for FHFA. It has, for Fannie and Freddie, it has somehow, over time, kind of taken, because of the conservatorship, you know, has really kind of dulled the sense of being a regulator at FHFA. A, because it's easier to do things via conservatorship and just tell the companies, rather than promulgating through rules and regulation. But you've also lost a sense of arm's length regulations. To me, critically important for any regulator, you know, not to get captured. Of course, it's just a reality that every regulator, whether it's the credit unions or the big banks or the Fed, there's a degree of capture at every financial regulator. There's certainly, unfortunately, that at FHFA. And so, part of this was meant to kind of create that insulation. But, at the end of the day, the role of FHFA is to be the regulator for Fannie and Freddie. A lesser role, by statute, is to be the resolver of a failed GSE. And, unfortunately, the day-to-day at FHFA has become to be dominated by the conservatorship.”
Jon: “I feel like it's been an interesting saga from September, autumn of 2008. Fannie and Freddie go into conservatorship. They've been on the balance sheet since. And there's been, I feel like, the saga, it's been 14 years, discussions about the net worth sweep. There's still shares of Fannie and Freddie that are being traded and held by some hedge fund managers. Occasionally, I feel like they go on TV, almost like an activist investor in some ways to suggest that there's maybe some reforms coming down the pipeline. Certainly, I feel like this was maybe after the election of President Trump. I feel like there were some of that who, you know, people were over speaking their hand. But I totally understand what you mean by sort of capture, too, because when I was working in fixed income asset management, it was interesting because, and this is in the post-crisis era, Freddie Mac and Fannie Mae securities were sort of thought to be risk-free securities. But they were treated like that in the risk models. And what's interesting is, I guess, some of this academic literature, there's all this discussion about, how do we manufacture risk-free assets because we don't have enough? And what's interesting is, I feel like in some respects, Fannie and Freddie securities have sort of become...”
Mark: “I mean, there has been a regulatory demand. I'll say as an aside, you know, it's interesting. In the post-financial crisis, there was, you know, a lot of criticism thrown at efficient market hypothesis and other things. And I'll say for my seven years in the banking community, I never once heard anybody utter the phrase efficient market hypothesis. And where I'm going with this, I think one of the truly, to me, most dangerous academic notions of financial regulation is this notion of a safe asset. There are no safe assets. It's, for instance, good to remind ourselves, First Pennsylvania Bank failed in the 80s due to its treasury holdings, interest rate losses, of course, in its treasury holdings. Nothing is risk-free. And the approach of financial regulatory treats certain assets as risk-free. I think it's been a disaster. It's certainly worth remembering that financial regulators pre-2008 treated Greek sovereign debt as risk-free. They all knew it was not. But it gets in its more political process. So I do think we need to have FinRank and the academic conversation around it just abandon this. I mean, I understand just like we talk about a risk-free rate or we talk about a riskless asset. Those are really helpful classroom abstractions. But they-“
Jon: “They are a useful benchmark.”
Mark: But they are useful benchmark but they're not reality. And of course, we know that models aren't supposed to be reality. But in this case, they so distort the conversation. Now, some of this is, of course, self-serving. I mean, when I first joined the Banking Committee of the Senate in 2001, one of the first meetings I had was a couple of guys from hedge funds coming in and trying to convince me why the Banking Committee needed to push the IMF to bail out Argentina. And of course, we're all familiar with the problems in Puerto Rico. One of my favorite stories from financial services history, if you will, is in the late 60s, Penn Central Railroad was one of the big banks. Goldman was their commercial paper underwriter. And because at that time we had the ICC News Day Commerce Commission, which we thankfully got rid of. Well, for railroads, all of their debt issuance had to be approved by the ICC. So, you had a common perception that railroad debt would be backed by the government. And, of course, that was the common perception with Penn Central. And, of course, if Penn Central failed, it was not bailed out. And Goldman almost failed for the litigation on being sued for being the commercial paper underwriter. And so, I really want to emphasize Congress has never created the supply guarantee behind Penn Central, but it's been created by Wall Street. It is a, oh, you should rescue me. It's just the same argument with when Wall Street, you know, gathered around to try to bail out New York in the 70s. Oh, you know, it's the government. So, some of this, to me, is just self-serving spending. Nothing is risk-free. Everything was bought with risk. If you're treating it as risk-free, you're not doing your job. As an asset manager, or as a financial regulator. And, again, I recognize it's so much the market that we know, for instance, that, you know, PIMCO and others heavily lobbied Treasury in 2008 to make sure that their agency holdings were taken care of. And I don't blame everybody's got a right to lobby the government to cover their losses. The problem is government steps in and doesn't all the time. And that's how we, you know, policymakers need to be on account that you're not expected to honor imaginary guarantees that are on paper.”
Jon: “Absolutely. And, you know, it's interesting, you know, speaking of sort of taking risk, I want to sort of move into, I think that, you know, clearly the greatest part of your legacy as FHFA director, and that being the capital rule for Fannie and Freddie. Can you speak a little bit about, like, you know, how the Fannie and Freddie balance sheets operate, and how leverage works? Because I think there's a bit of confusion, I think, with, you know, Fannie and Freddie, people just assume they're part of the government.”
Mark: “And, you know, and even the question of balance sheets. So there's a division of views. The Congressional Budget Office, you know, you and I both worked on the health and correctional budget offices of the view that Fannie and Freddie are on the balance sheet. And, of course, the Office of Management and Budget and White House is of the view they're not. And so it is important to keep in mind, there is no statutory guarantee of Fannie and Freddie debt. It's an assumption that government will rescue them, because government has rescued similar actors in the past. And, of course, unfortunately, the regulatory system that has built up by this, you know, by the financial regulators has reinforced that view. And, of course, the fact that the Fed uses agencies during, you know, quantitative easing and other monetary operations reinforces that view as well. So part of the problem you do have is that the financial regulatory system itself, outside of congressional intent, has taken actions that reinforce the perception and the reality of assistance for FHFA. [Inaudible 0:18:09] Fannie and Freddie. But so, let's start with this premise. I mean, the real intent of HERA, the House of Economic Recovery.”
Jon: “From 2008?”
Mark: “From 2008, [Inaudible 0:18:20] FHFA, was to create a regulator for Fannie and Freddie that would have supervisory powers and responsibilities on par with other financial service regulators. And so it was a sense of, well, you know, like it or not, you know, these are highly leveraged financial institutions. There need to be a regulatory structure to protect them. So one of that, of course, let me say, I like to actually think my biggest legacy that I hope to stick is simply getting the agency to see itself as a financial regulator. And, unfortunately, you can see this, you know, during my nomination process and some of my time there, where some of the press would characterized me as a housing regulator or something like that, FHFA is not a housing regulator. It regulates mortgage lenders. It's no more a housing regulator than FDIC is an auto regulator, simply because banks hold auto loans. But part of that narrative is meant to distract from the fact that it is a safety and soundness regulator. The problem, fundamentally, is that most of Washington doesn't want to be regulated for safety and soundness. And there are no on-budget statutory subsidies behind Fannie and Freddie. It's really just an attempt to use implied guarantees and risk-taking. So the consensus, again I go back to 2008 was Senator Dodd and a number of Democrats coming together and saying we wanted to do something for homeowners in distress. We wanted to create a trust fund to provide affordable housing. And then the ask, if you will, the other side of that deal from Shelby and the Republicans was, okay, but we need to set this up in a way where the taxpayers are never asked to bail out these entities and that they have regulation on par with other institutions. And I would sometimes half-happily joke that my objective was to have Fannie only be as highly leveraged, poorly managed, mismanaged, and poorly regulated the Citibank. And again, because how do you get them to be on par? And so certainly we started a system of just trying to get the agency and the entities themselves to see themselves as a large financial institution that needed to be regulated on par. Because again, by size, Fannie and Freddie are multi-trillion assets. I mean, they are SIFIs in all but name. They're comparable to JPMorgan Chase, Wells. I mean, again, if Fannie's not significantly important, nobody is.”
Jon: “I guess the main difference is that their gains and losses are being transferred to the Treasury Department.”
Mark: “They can be. They have been. They don't necessarily need to be. In fact, one of the other things that we set up when I was there was a resolution regime. We started doing living wills like those done under the Dodd-Frank for the largest banks. We did those for Fannie and Freddie.”
Jon: “This is OLA kind of...”
Mark: “Yeah, the orderly resolution stuff that came out of Dodd-Frank. So we copied a lot of Dodd-Frank. But honestly, Dodd-Frank copied a lot of euro. It took many things we did for Fannie and Freddie to apply to the large banks. And so we really, you know, we brought over staff from FDIC. We brought over, for instance, some of the team that worked on any MAC resolution to help create a resolution team. We did coordinating exercises with the SEC and with the Fed on, you know, were Fannie and Freddie to fail, how would we resolve them in a way that did not cost taxpayer money? So there's a lot of exercise done internally with Fannie and Freddie. So my view is they can be resolved today without cost to the taxpayer and without disruption to the mortgage market. We know that. Do I think that this administration or really almost any administration would follow with that? Probably not. But again, they certainly won't if the infrastructure's not there to do it. And so I left behind an infrastructure to appropriately resolve V&A and Freddie in the case of insolvency without taxpayer support. So any future bailouts of V&A and Freddie will be bailouts purely of choice, not necessity. But that said, you know, you don't want to, you know, rely on resolution mechanisms. This is your first line. Resolution mechanisms, whether it's for a large bank or whether it's for Fannie Mae, you really want that to be your last option, not your first.”
Jon: “Or after, you know, when things go wrong, I guess.”
Mark: “Exactly.”
Jon: “This is like a post-crisis sort of tool versus a preventative tool in the same way that sort of capital rules were, at least, you know, the Don Frank capital rules for banks. But I guess, you know, those left out of the GSEs community.”
Mark: “And both, so both in the bank context as well as the GSE context, I mean, your insolvency is just that. It is the assets being worth less than the liabilities. And so the way you want to avoid that, of course, is to have sufficient equity to cover that. Fannie and Freddie went into 2008 being leveraged over 60 to one. So my view was they were guaranteed to fail. Nobody that kind of leverage survives a crisis. And, you know, keep in mind that, you know, even Lehman and Bayer were less leveraged than Fannie and Freddie. But again, going into crises of that levels of leverage, particularly when your assets are predominantly in a very volatile asset class like housing. And so one of the things we instituted, and again, I don't want to take too much credit because Congress told us to do it, and I'll set aside the fact that Congress told FHFA in 2008 to do a capital rule. And it took about a decade, even for the agency to think about it. So from my view, that's massive dereliction of duty not to carry out a capital rule. But one of the important provisions of the capital rule, and this is one thing where I think Fannie and Freddie are so critically different than banks. Depositories really are inherently pro cyclical. You're going to expand business with the business cycle and you're going to contract otherwise. Fannie and Freddie certainly act pro cyclical, but that's not what their charters are. That's not why they were created. They were created, you know, to be a floor under the market in time of stress. And so even in their charters, it says they're required to set terms and conditions so as not to have excessive use of their facilities. And so the market's not supposed to depend on Fannie and Freddie day to day. Of course, we've gotten away from that and there are whole segments in the mortgage market that only exist because of Fannie and Freddie. But all that said, the year in 2008 required the capital in the downturn, but they'd still maintain sufficient capital to do new business, because of course their purpose is to be able to do business in a stressed environment. So I hope it sticks, but one of the things that I was working on was getting the companies in FHFA to essentially re-embrace the charters, to remember why Fannie and Freddie are here, and to get the companies to see themselves as these countercyclical firefighters, rather than the arsonist who shows up and burns the house. Or as I like to say, for those of our college listeners, the guy who comes over the night of the party, the loudest guy at the party doing keg stands and such, he's not going to show up the next day and help you clean up. And you've got to remember that Fannie and Freddie's role is to be the guy who comes by the next day to help you clean up, not the loudest guy at the party. Historically, they've been the loud guy at the party. The loudest drunk at the party, that's been them in the mortgage market. And getting them to understand and see, and getting them to realign their behaviors with their actual statutory mandate, was a big part of it. And it gets to the fact that so much of regulation really is soft in a way. I mean, it's the culture around it, it's the expectations around it. And so really resetting a lot of that, I think, was important. For instance, we started corporate culture initiatives, both at Fannie and Freddie, who in my view, historically, had really broken corporate cultures. But part of it was they never really saw themselves as that countercyclical fireman coming to the rescue. They never saw themselves as responsible for policing behavior in the mortgage market. So a number of things we had to fix. And unfortunately, there are a whole list of things that are still unfixed at both companies and at FHFA.”
Jon: “Now, prior to the capital rule, what was the leverage ratio that Fannie and Freddie were running? I remember-“
Mark: “Well, when I walked in the door, it was 1,000 to one, which of course, you sneeze and you fail. So I mean, there was pretty much no margin. So I am happy that I walked in the door, it was 1,000 to one. When I walked out the door, it was about 150 to one. Still too massively leveraged. We also were able to end the so-called sweep. There was a profit sweep instituted by the Obama administration in 2012 that really was meant to box in Fannie and Freddie, contrary to statute. I mean, there's nothing stopping the Obama administration from lobbying Congress and getting a new framework. But you really have this profit sweep that was meant to keep them in limbo, which again, is completely contrary to what the statute is. So we ended the profit sweep. And the importance here was, if we hadn't done that in 2019, and I'll say this, there was no sweep during my tenure. We formally ended it in September 19, but it was ended functionally when I walked in the door. If we hadn't built up capital, Fannie and Freddie would have failed from the COVID losses. So the fact that, you know, you never get credit in D.C. apparently for regularly avoiding failures.”
Jon: “Right.”
Mark: “But we did. We built up capital, we got Fannie and Freddie focused, and they survived COVID, and they would not if we hadn't made those choices. So I think that should be an important win, you know, for not having to tap the taxpayer again. But we also changed the mindset. So for instance, you know, there are, I mean, this is, there's a debate legally over this, but Treasury and many others were of the perspective that they have an extended line of credit to Fannie and Freddie that comes out of 2008. My view is the statute very clearly says that those lines of credits have expired. But all that said, these form under the so-called draw. And I made it very clear to the CEOs and the chairs and said to them, you know, were you to ever come to me for a request with a draw, they'd better be accompanied by your letters of resignation. And even that does not guarantee that we'll take any money from the Treasury. So simply changing. So for instance, when I walked in the door, Freddie and its financial reports, its 10-Ks and Qs, had listed that the taxpayer provided their capital, which was certainly not true. So we need to change that. And more disclosure to the appropriate position, you know, financially in the company. So I do think, I hope a big set of accomplishments is resetting the facts, the truth behind a lot of it. But we said that there's kind of a mythical narrative and charter around Fannie and Freddie. And then there's the law. Unfortunately, the mythical has dominated a lot of the conversations in Washington. And so I really saw a lot of my tenure as, how do we simply get FHFA and Fannie and Freddie to follow the law? Do you think that would be, you know, something everybody could agree on?”
Jon: “Absolutely. Well, you know, in the post-COVID world, its amazing just thinking about the FINREG, the new FINREG era that we live in and have been living in since Hera and Dodd-Frank and how it was essentially tested in 2020 when, you know, there's this COVID shock to markets. And I feel like a lot of those who are fans of Dodd-Frank, there's been a lot of patting on the back. And then perhaps, you know, to some degree, rightly so, in that these capital standards were started for banks. And I mean, there's a lot of other things in Dodd-Frank, too, that I think have been either worked out since or have been rethought a little bit. But I think, you know, there's at least some consensus that, you know, capital rules for banks prevented some distress. I mean, I'm sure, you know, we'll never really know the counter facts.”
Mark: “I mean, one could get on a rabbit hole on bank capital standards for a long time. It's important to keep in mind that almost all of the capital increases post great financial crisis happened outside of Dodd-Frank. The Basel process and Basel III, which was an improvement over Basel II, that was independent of Dodd-Frank. And so, you already saw a move to increase the quality because you had a lot of stuff pre-2008 counter capital that was not loss absorbing. So we improved the quality and quantity of capital, but all of that would have happened and did happen independent of Dodd-Frank. So I think there's just too much pat on the back of Dodd-Frank. I mean, my view is that 2008 there was a massive bailout by the Federal Reserve as well as assistance provided across. So I don't really, I mean, to me that was to kind of say 2008 proved Dodd-Frank worked. You know, either they're talking...”
Jon: “Or not Dodd-Frank, but just capital standards in general.”
Mark: “I mean, you know, some of it is because you so much pushed everything else. You know, I mean, for instance, certainly the Fed's actions in March 2020 were a rescue of the broker-dealers to have reached their capacity in terms of both treasuries and agencies. It was a rescue of mortgage rates, if not rates writ large. And so you had a lot of rescues that were provided. And, of course, there were, you know, flexibilities given the banks. And, of course, the banks, you know, I saw this with so much of the non-bank mortgage industry relies on lines of credit from commercial banks. Commercial banks were not. They were pulling back. They were not looking to extend those lines of credit. So I think there's a lot of fragility in the mortgage market and the financial system writ large that essentially the Fed papered over in 2020. And so, to me, you know, I still think many of the institutions in question, you know, are much too leveraged. But, of course, there are other problems. I would argue the biggest problem facing the banking industry today is the historically low loan-to-deposit ratio. You know, Dodd-Frank has essentially, among other things, pushed the banking industry to be essentially the funder of government, where instead of making loans to small businesses, they're holding treasuries and agencies, which to me is not the way to grow the economy. And that's a whole other separate conversation.”
Jon: “Absolutely. I mean, I guess at the very least, you know, we can, I guess, agree that banks sort of avoid calamity, possibly in part due to capital rules. And then certainly, you know, GSEs, you know, thanks to your hard work in removing risk from the system and paying Freddie and reducing the amount of leverage and putting them on a path to having a capital rule helps avoid, you know, another GSE crisis. And then, but for some reason, you know, money marketing for funds, we have not quite solved that one yet. There are some serious problems there. And, of course, it bears saying, both for Fannie and Freddie as well as the banks, the record and unprecedented amount of household stimulus, whether it was not only extended amounts of unemployment insurance coverage, but who was covered, and the relief payments. And of course, that's coupled with the fact that people were stuck at home. You weren't spending on that European vacation. So the amount of just liquidity that was thrown at households. So one of the reasons, of course, that Fannie and Freddie and the banks were at large came through this is because some of this was, of course, mitigated by our activities on mortgage remittance. You didn't see the loan delinquencies that you saw in 2008. And so I do worry because it certainly shouldn't be the precedent that we avoid financial crises by avoiding delinquencies by just flooding households with money. I mean, it's probably better in some sense directly helping Main Street than to help Wall Street, but it's also not terribly well-timed. And as we've learned, it results in tremendous amount of inflation.”
Jon: “Absolutely. We'll get back to fiscal policy and monetary policy on this, but just to sort of close it on the FINREG type of things. You were removed from office by President Biden following the Supreme Court ruling. I think one thing that's a fascinating and fantastic part of your legacy is that your successor, Sandra Thompson, has actually kept the rule in place with some tweaks. I'm curious. Could you explain that whole process and what happened there? I mean kind of an administrative law question in terms of what kind of agency heads a president can fire and what was that Supreme Court ruling all about.”
Mark: “It was known as the Collins case. It started out as Collins v. Mnuchin and ended up as Collins v. Yellen. And, of course, a bit of an irony is that the removal language in HERA in question, I wrote myself like 15 years ago. So it's one of these weird things where what was declared unconstitutional that I did the legal research on and still believe is constitutional. So it gets back to, fundamentally, whether you want to think of it as the W.E.B. and Terry, the theories of the executive, but it really comes down to the constitutional requirement for the president to make sure that the laws are faithfully executed. And so the debate, and, again, I should qualify this as I'm not a lawyer, even though I've worked on many of these topics for an administrative law and a legislative side, but the debate fundamentally gets to is the president able to fulfill his constitutional requirement to see that the laws are faithfully executed if he cannot fire at will people who are executing those laws? There's a school of thought, again, the inter-executive that takes the view that it's simply the president cannot fulfill those responsibilities unless he's able to remove people at will. I'm not of that view, quite frankly, and I understand it. A, I would say I don't think it's strongly grounded in the Constitution. It's not a lot of grounding. There is an argument there, there is a logic to it, but it's not based on an explicit sort of the President should be able to remove whoever he wants. And certainly when we drafted HERA in 2008, it was very much within the norm of constitutional law, which of course changed since then over the direction of independent agencies. And so the debate was whether the head of FHFA could be removed at will or whether it can only be removed for cause. And this is my disagreement with my unitary executive friends, is I do believe that an agency head who is not carrying out the law faithfully can be removed because that's for cause. So you have an ability to remove a person. And in fact, the irony is I was, in my view, largely removed before following the law. So again, the actual result of the decision. So you had a number of shareholders to pay in credit who sued after the Third Amendment. Here's the other irony. The case, when it started, was never about me. This was litigation that started before I was ever in place. It's litigation that goes back to the so-called Third Amendment profit sweep of 2012. And of course, that was signed by Ed DeMarco, who was an acting director. And it's generally accepted that acting directors can be removed at will. And I would go as far to argue that you never would have had the profit sweep in place had it not been for an acting. In my view, any permanent director would have pushed back on the White House. But in my view, Ed didn't have that luxury because he was acting. So there's a bit of an irony that the litigation itself, the plaintiffs take the view that they were harmed because the structure of the agency is unconstitutional because the director is not removed at will, when the fact is that they were probably helped by that, if anything. So that made it to the Supreme Court. And this was, of course, following a year after the CFPP case that got to the structure of CFPP. And, of course, I think there are fundamental differences between CFPP and FHFA. But, of course, the court did not see it that way. And so we ended up in a position where the Supreme Court said that FHFA director could be removed at will. Now, of course, the Biden administration, we have a number of positions in government such as, you know, it's not unusual for, say, CIA director or FBI director, obviously, departures from this to be kept. So in spite of the fact that then Senator Biden voted for an independent FHFA, you know, the view of this administration was, you know, we don't like what Calabria is doing. He's following the law. We can't have that. They didn't quite articulate it that way. But at the end of the day, you know, they decided that they wanted to move on. Again, you know, their initial choice was not Sandra Thompson, who has a long-time career. She had come to FHFA from FDIC, and she eventually got the nomination. And again, she'll be removed when a Republican comes in, you know, because that's the new norm. And as you know, at the beginning of the Biden administration, a number of positions like, you know, General Counsel of the National Relations Board, people at, you know, the Service Academy Boards and stuff like that. There really was an unprecedented wholesale removal of people from those positions in a way that had never been done before. In the general sense of the Republicans, that's now the rule. Everybody else. Of course, there's really no reason why this doesn't apply to the Fed, for instance. I mean, the chair of the Fed or the vice chairs of the Fed, those are positions in addition to their board seat. And so certainly under the logic of Collins, you know, you could be removed from them. And so I do worry because—and Collins very clearly applies to the OCC, and of course we've got that case with the CFPB, and of course we know that means that most of the FDIC board, a good chunk of it, is no longer independent either. So I do worry in terms of financial stability, the temptation from any White House to want to engineer an expansion in credit or particularly an expansion in the housing market leading up to election is going to be incredibly strong. And so I worry that we—much of our financial regulatory system is now very heavily politicized, and we've seen a loss of independence from the political process, from the White House process, that I think ultimately will end up in more crises because the temptation really is credit. And you've seen this. I think it's fair to say that most indicators are that the housing market is softening. You've got a number of markets where prices are actually falling. But what is the response of the Biden administration? Ease credit standards. We're seeing these things where it's like, who needs a down payment? So I'll worry that rather than focusing on the property markets is what any regulator should be doing at this moment, the focus is on expanding an agenda of pushing people into unsustainable loans. And again, I think if the regulatory system was more independent, we'd have less of this. So I'm very worried about what I think the long-run outcome for the Collins case will be. I mean, obviously I'm not unbiased. It's put me out of a job. And I wrote the underlying language and have some pride of ownership. But this really threatens the independence of our entire financial regulatory system. And I think ultimately that won't end up well. I don't know what the solution is. I mean, the short-term solution would be to take the OCC and FHFA and make them boards, and that gets you a short-term solution. But the logic of Collins does have a strong impact on boards overall. And I think it's fair to say, I certainly think in the current environment, you can count at least Thomas and Alito, and maybe even Gorsuch and DeCampo, seeing any independent regulator such as the Fed is unconstitutional. So I think we're headed for a continuing interesting period in terms of financial regulation going forward.”
Jon: “Absolutely. I feel in terms of politicization of finance and government promotion of credit, I feel like if the student loan forgiveness saga was late, just a few months ahead of the auction, and there isn't a sign of some movement towards further politicization of finance and credit access, I feel like that may be a good example. So just to close the note here on FHFA, and one, I think one is a huge victory that your successor has kept the capital in place with some minor tweaks, and is a huge part of your legacy. I'm curious, going forward, there's this always classic question of will Fannie and Freddie remain in conservatorship or eventually be privatized? And in the privatization camp, I think I've always said that the capital rule was a precondition to this. I'm curious, one, what's your own view, just succinctly in terms of conservatorship forever versus privatization?”
Mark: “So there's a couple of things that need to be parsed out there. And let me say, I think one reason why much of what I did do was kept is because, A, everything I did do was grounded in statute. So, I mean, I didn't really, my agenda was, not to have my own agenda, my agenda was what has Congress told us to do, we're going to do it. And I think that for an agency, when you ground your agenda in simply fulfilling the explicit rule of Congress, you're much more durable and you're in a much stronger position than if it's just whims. And so I think that was a big part of it. You know, I do want to say, I mean, still, Fannie and Freddie, as by statute, are private entities. They're no less private than Hertz was going through bankruptcy or Brooks Brothers was going through bankruptcy. You know, these never stop being private companies. So under law, sure, they're GSEs, but they, and I'm the first to say that GSEs have an ambiguous structure, but certainly under statute, they currently are private shareholder-owned companies, which is why the shareholders are still outstanding. They are required to be fixed and gotten out. Either you fix them and put them out or you put them through receivership and eventually get them out that way. But to me, certainly, there's no way to read the law, in my view, that justifies an endless conservatorship. There is no statutory provision that requires Congress to approve an exit from conservatorship. That's not true. I don't really know how that ever got started, is the view. Part of this has been a back and forth where some asset managers and holders of agency debt have wanted to use the reform process to get an explicit guarantee not only on future GSE issuance but also current GSE issuance, which would obviously be a massive windfall for these companies. And they've had a bit of undue influence, in my opinion, on the process where they've delayed the process. To me, 90% of the problem with Fannie and Freddie can be fixed if simply the existing agency and Fannie and Freddie all follow the law. The problem, of course, is that much of the stakeholder community in Washington doesn't want them to follow the law, because that would result in a less favorable benefit. I should lastly say, because this is such a critical point, it goes back to when we started the conversation about market structure. Eighty-five percent of the debate about the regulation of Fannie and Freddie is fundamentally about differences in market share among originators. It's a whole host of the mortgage industry that solely exists and solely profits because of the existence of Fannie and Freddie. And so anything you do that impacts the cost of Fannie and Freddie relative to the rest of the mortgage market could mean the definition of whether these companies survive or not. So for them, it's a life and death. But at the end of the day, I never thought it was the role, because it's not the role of the FHA statute, to figure out what a non-bank versus bank share of the mortgage industry is. But unfortunately, so much of the conversation in Washington really is caught up with, it's got nothing to do with expanding ownership. It's got nothing to do with making housing more affordable. It's really all about relative market shares among originators. And I think that that's really muddied the waters until I think we get past that. You're not going to see a fix to the system. So I should certainly end up maybe on a bit of a dour note and say, you're surely not going to see congress do it anytime soon. You're not really going to see this administration do it anytime soon. I think this is going to have to rely on the next administration to make a choice. And to me, the choices are going to be perhaps in a little more than two years. A, have we gotten through this housing cycle in a way that has not been massive losses? And that Fannie and Freddie are, you know, prices are going back up, housing market, Fannie and Freddie are making money, and you get them out of a new conservatorship. And then I think a Republican administration would look at this and say, how can we do this in four years? And if you can't, and Fannie and Freddie are losing money, then I think any Republican administration would look at this and say, well, receivership is what we've got to do, because you cannot simply trust a future administration of almost any party to have these entities and conservatorship where they essentially can be lifted.”
Jon: Fantastic. Just two, some last questions on fiscal policy and monetary policy. In your whole career, you've spent a lot of time across the FINREG fiscal policy and monetary policy spectrum. So, you know, one, on the fiscal side, housing relief. You know, we've seen a lot of things since sort of the global financial crisis and Great Recession era. Housing relief, mortgage finance, you know, for mortgage finance homeowners, rental units. You know, we've seen, you know, one sort of regime then. You know, we've seen sort of another new one appear in this COVID-19 era. I'm curious, you know, do you think that that sort of, you know, on top of housing relief, just in general, you know, fiscal relief, transfers, stimulus checks, you know, PPP, you know, all these things. And, you know, even the infrastructure built up, you know, we saw in the Great Recession era, which maybe were a little notch up already in Obama's terms.”
Mark: Yeah, he had forgotten all that.”
Jon: “What do you think the, you know, the big fiscal policy mistakes have been, and what do you think has gone well?”
Mark: “I mean, the mistakes are probably easier to identify. I mean, first of all, the length and the magnitude. So, for instance, you know, we had a shot at COVID, but it was pretty clear to me by June, July of 2020 that we were already seeing a strong recovery in the job market. So, both from a monetary and fiscal standpoint, you should have been building back at that point. You know, and to the extent that the monetary was also financial stability, you know, I kind of put it this way, and I said it earlier, that part of the monetary response was to assist, you know, distress in both the Treasury and in the agency market. Well, it only takes a couple of weeks for, you know, people to dump their MBS book onto the Fed. This is not something you need to do for two years. So, I think by late December 2020, we already should have seen a turn to the direction that both the Fed and fiscal policy was taking. You know, certainly having better targeted, I mean, I certainly don't think the higher income households needed the stimulus payments. As we also know, there were a rather large percent of households that were getting more, unemployment with the plus-up than they were even working. And, of course, you know, in April, May, maybe we didn't really want them to work, but certainly by July. So, I think, again...
Jon: “By July 2020.”
Mark: “2020, yeah. So, yeah. By 2021, there's no rationale. There's no real economic rationale for these approaches by 2021. We've already seen most of the job recovery. We were in a strong recovery. You know, people were through most of it. And, again, we had some sense of what the light at the end of the tunnel started looking like. So, I think most of it was poorly targeted. You know, certainly, you know, the PPP approach of trying to keep people fast to their jobs made sense. I think there's some problems with PPP, but the overall approach was probably the right one. The overall approach with assistance was probably the right one. Again, not well-targeted and lasting too long. I think the things we did get clearly right was the approach, not just to mortgage assistance, mortgage forbearance, but the way that was done across the board where it really was forbearance rather than forgiveness. Obviously, in the student loan space, we've now gone from forbearance to forgiveness. Some of this really is, how do you make sure that these policies are targeted to the problem at hand? I worked not only on the financial crisis stuff, and then I worked on Katrina stuff when I was in the Hill response. You see this kind of after every crisis where you can channel the old Rob Emanuel and every other crisis is a good waste. This is the frustrating part to me is that rather than focusing on how do we have policies directly targeted to the crisis at hand where we can get people back on their feet, it's often used as a cover of how do we grab as much as we want for favorite constituencies. Certainly, that's what we've seen. It's obviously extremely disappointing. I think in the long run, for those who want to be able to build a legitimacy of a quick government response to crises, should really be concerned because if the public looks at this and every crisis response just gets characterized by looting and theft and reward of special interest, you're going to undermine the credibility and the public support for those things in the long run. To me, again, too much, too long. That's not to say the alternative is not nothing because I think this is really the topic of my book, which is how can you provide a response? How can you have it targeted to the question at hand, and how can you do it at low cost? For instance, during my time at FHFA, we provided assistance to almost 3 million households. We targeted it in such a way and structured it in such a way that we recovered almost all the cost of it. We didn't add to inflation. We didn't add to deficit. We covered it within the mortgage market, and we provided assistance targeted to those who needed it. I think that hopefully that framework of the book can be adopted in the future and used not just in the mortgage context but any context because there is a right way and a compassionate way to do it, and then there's just the way we've always done it.”
Jon: “Well, I'm super excited to read the book. I'm at Shelter for the Storm. One last question, monetary policy. Any thoughts on the current inflationary environment, the Fed, and global monetary policy reaction to it? One, do you subscribe to a certain view in terms of what were the primary causes of inflation? Not something being debated enough in my opinion, but do you think the Fed could have reacted sooner? How would you assess the Fed's overall response?”
Mark: “I think the Fed has been way too slow on this, and again, my view is they really started normalizing in the second half of 2020. It was clear we were through the worst of it, and this is often a problem. I think this is the problem [Inaudible 0:55:08] , I think this is the problem post-2008, is that rather than just going in and dealing with the near-term issue of distress in the financial markets, our distress in the economy, the Fed just keeps the foot on the gas for years on end. And then by that point, it's fed into asset prices, it's distorted the financial system. So again, often what should really be three to six months of assistance ends up being two to three years. And the Fed just repeatedly makes this mistake over and over again. And so to me, again, it's certainly not the way I would have done it. And again, I would have provided assistance. So all that said, the debate about whether this is primary or fiscal, I mean, to some extent, yes, I think we overdid it on the fiscal side, but I think the Fed accommodated that. Had there been, the Fed certainly could have on its own offset all the inflation coming from the fiscal side. They chose not to, they chose to accommodate it. So to me, I think they're kind of like, who's to blame here? And of course, the Fed bears some blame, as you remember, certainly in 2020 and beyond. You know, the Fed was some of the loudest voices for fiscal assistance. You know, go big, can't do too much. Yes, you can do too much. And so again, I think the Fed really kind of missed the ball here, I think was extremely behind the curve. That said, you know, I mean, we've started to see the last several months money growth come back to much more normal. And so looking at money growth, looking at other indicators, I do think we're getting a moderating of inflation. Do I think the Fed is going to be at a 2% target by the middle of 2023? No, I don't. But we may be 2024, 2025 back to a sort of 2%. But I think we, fingers crossed, may well be past the worst of it. But it's also certainly important to keep in mind, people still aren't going to like 5% inflation, 4% inflation. So I think we've got a ways to get there. I think this is a real test, because while Powell and many members of the Fed have said the right things, we really have seen almost no unwinding of the Powell sheet quite frankly. I think they are doing the ordering correctly. I would unwind the balance sheet before I would have raised short-term rates, because you risk, you know, intentionally or unintentionally inverting the yield curve, which has lots of adverse consequences for the financial system. So to me, until we really start to see, you know, some significant change in the balance sheet, then I'm going to, you know, call me skeptical until we get there. So it's, you know, it's a wait and see at this point. But obviously, I wish them success in this. Nobody wants to have inflation. Nobody wants to have a hard landing. But I do think that all of this was avoidable and foreseeable and was foreseen by a number of people. So, you know, even if the Fed manages to pull out of this, I don't think we should be doing victory laps because all of this got avoided.”
Jon: “It's fascinating, you know, just starting to see inflation expectations start to come down a bit. And maybe some evidence that inflation is starting to slow down. You know, you see the market, you know, react jubilantly to these, you know, these individual prints. I mean, it's also so interesting, too, just on the physical side, how we went from a decade of talking about secular stagnation and there not being enough demand. Not everyone was talking about this. And now we've gone to this place where, you know, there's too much demand. I feel like just over the span of a couple of years.”
Mark: “I think if you go back, you know, you really look at the policies that were put in place in 2017, 2018, and 2019. I think we illustrated that secular stagnation was not real. We showed that you could have increases in productivity. We showed that you can actually turn around labor force participation.”
Jon: “In real wages?”
Mark: “In real wages and real wages at the bottom. And show that you can grow the economy in a non-inflationary manner. You know, and so to me, I think we've got the demonstration of it. Anybody who doesn't think that the policies of 17 to 19 works, you know, doesn't want to believe it.”
Jon: “You know, with the ARP and sort of successive fiscal bills layering on that sort of drove more of the inflation side of things and then the demand came to a halt.”
Mark: “Yeah, and of course, some of this is just the misinformation and the economic illiteracy of so much of the conversation. One that probably grates me the most is that, I mean, you had this entire campaign of trying to characterize the 2017 tax reforms as geared toward the rich when, of course, they made the individual side more progressive. You know, to me, when I was certainly coming out of grad school, it was widely accepted that the, you know, corporations were pastors and the burden of the corporate tax was borne by workers and shareholders. And so the willingness to play on the, of misperception. I mean, who thinks that we really need a global corporate tax cartel by governments? I mean, the optimal corporate tax rate really should be zero.”
Jon: “Right.”
Mark: “You know, so I do worry.”
Jon; “I feel like it's an optics thing there. I don't think any reasonable person, you know, doesn't think that 180 countries and all the legislatures are going to pass a 15% corporate tax. But every executive will want that to be worth buying a corporation.”
Mark: “The fact that people generally know, fully know about the importance of the corporate tax and say otherwise is a disappointment. I do believe that we're, it's, we've thrown away decades worth of capable experience. You know, whether it's NMT or whether it's thinking that, you know, that marginal tax rates don't matter for behavior, or thinking that, you know, everything's a monopoly. I just kind of feel like we're, you know, we've entered a dark ages in terms of economic policy, to be frank about it. And I do think the profession, you know, really needs to re-engage, because at the end of the day, good economic policy matters in terms of living standards, in terms of equality, in terms of growth. And so, and of course, there's the set-aside issue of, you know, when we were doing mortgage finance reform in 2008 that led to FHFA, the issue that Barney Frank and Nancy Pelosi fought hardest for and wanted the most was to expand the loan limits to include richer people. And the fact that so much of government, whether it's student lending, whether it's mortgage lending, whether it's the SALT debate, really...”
Jon: “Mortgage interest deduction.”
Mark: “Yeah, and I'm just so proud that we were able to lower the mortgage distribution as well, so I'll tell you something. But the fact that so much of economic debate on the left simply becomes about how do we loot government on the half, on the behalf of college educated elite, rather than any sort of, like, how are we actually trying to grow this economy for everybody? So, again, it is... This is the most depressing era of economic policy I've ever lived through. So I'm hoping that the counter-reaction to that will get us back on course, where we can have a prosperous economy, because it's doable. Again, I think we showed 2019 is the best economy in my lifetime, and I think that's fair to say by any objective standard, and I think we can get back to that with the right set of policies.”
Jon: “Well, I think that's a wonderful vision of hope for the future, and it is sad that we have to sort of, or a number of people have to sort of either relearn or learn these lessons for the first time through disasters, perhaps like the inflationary one that we're going through today. Well, it's been a real pleasure having you, Mark, and it's amazing to hear someone who's led such an important reform at FHFA who's worked in the White House and has been part of selecting Fed governors, and yourself, who have been considered for Fed governorship in the past. It's a real pleasure to hear your experience and views on all these things. Thanks so much, Mark, for joining us. Our guest today has been Mark Calabria, a Cato Institute senior advisor and former FHFA director, and author of a new book, Shelter for the Storm, coming out in the first quarter of 2023, which you can pre-order today on Amazon. This is the Capitalism and Freedom in the 21st Century podcast, where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Thanks so much for joining us.
