Fannie, Freddie May Need Another Bailout As Washington Drags Feet On Housing Finance Reform

Back in March of last year, the FHFA warned that Fannie and Freddie may well go bankrupt at which point taxpayers would once again be on the hook for subsidizing their own bad mortgage debt.

As you might recall, the Treasury changed the rules when it came to the GSEs a while back.

Whereas previously, the companies paid a dividend to the government on the preferred stock Washington owned, the Feds decided instead to implement a quarterly profit sweep. As Bloomberg notes, “the payments count as a return on the U.S. investment and not as repayment of the aid, leaving no existing mechanism for them to exit government control.” That’s irked equity investors who swear they’re being illegally swindled by the government.

On Thursday, we learned that Fannie was set to pay the Treasury some $3 billion after reporting $2.5 billion in profit for Q4. The company – which has received more than $116 billion from US taxpayers since 2008, has paid the government $147.6 billion to date.

“Fannie Mae’s 2015 net income was $11 billion, down from $14.2 billion in 2014,” Bloomberg wrote on Thursday. “One reason for the decline was higher income in 2014 following settlement agreements on lawsuits related to private-label mortgage-related securities.”

Because of the arrangement which prevents Fannie from holding onto its profits, the company’s capital buffer could be completely wiped out by 2018, CEO Tim Mayopoulos warns. “At that point it would be unable to weather quarterly losses and would need to draw on Treasury funds to avoid being placed into receivership.”

So ironically, the government’s attempt to extract payments from the GSEs in perpetuity has left them without a capital cushion which in turn will force them to … wait for it… ask for another government bailout. 

This is reminiscent of the rather absurd scenario the companies were in before Washington transitioned to the profit sweep model. Previously, when Fannie and Freddie owed the Treasury a dividend on the government’s preferred shares but didn’t make enough money to cover it, the Treasury would loan the GSEs the money they needed to make the payment. Obviously, that’s completely absurd but as you can see from the above, the alternative (forcing taxpayers to bail the companies out again because the government commandeers the entirety of the companies’ profits) is equally ridiculous. 

“The most serious risk and the one that has the most potential for escalating in the future is the enterprises’ lack of capital,” Fannie’s top regulator, and FHFA director Mel Watt said.

As FT recounts, Fannie CEO Tim Mayopoulos said “a range of options for solving the capital problem were available, such as allowing Fannie Mae to retain earnings, changing the terms on what gets Treasury support via preferred stock purchases, and taking it out of conservatorship so it could be recapitalised in another way.”

Of course all of that is politically sensitive. Taxpayers aren’t exactly excited about seeing these bastions of cronyism and outright waste and corruption privatized again and allowing them to hang onto a porition of their profits is the first step in that direction. 

Whatever the case, Americans should probably go ahead and come to terms with the fact that both Fannie and Freddie will be drawing from the Treasury over the next few years. Housing finance reform isn’t exactly moving at a breakneck pace and it’s not at all clear that income guarantee fees can offset losses from the decline in the GSEs’ retained portfolios. 

As for what further bailouts would mean for the health of the US housing market, we close with the following passages from Watt:

“Future draws would reduce the overall backing available to the Enterprises, and a significant reduction could cause investors to view this backing as insufficient. It’s unclear where investors would draw that line, but certainly before these funds were drawn down in full.”

“Investor confidence is critical if we are to have, as we do today, a well-functioning and highly liquid housing finance market that makes it possible for families to lock in interest rates, obtain 30-year, fixed-rate mortgages, and prepay a mortgage if they want to refinance or need to move. If investor confidence in Enterprise securities went down and liquidity declined as a result, this could have real ramifications on the availability and cost of credit for borrowers.”

Full comments from Watt to the bipartisan policy center

Thank you, Secretary Cisneros, for your opening remarks and introduction.  I also want to thank the Bipartisan Policy Center for extending the invitation for me to speak today on our work at the Federal Housing Finance Agency (FHFA).  I think all of you will agree that the things I am going to talk about deserve bipartisan attention and collaboration like we have seldom seen in recent years.   

This speech has two parts, an easy part and a difficult part.  Both parts reflect a philosophy that I hope all of you agree we have tried to encourage since I became the Director of FHFA – a philosophy of open, honest, and transparent discussion and decision making that helps demystify what FHFA, Fannie Mae, and Freddie Mac do and how those things relate to housing finance stakeholders.   

The first part of my speech is easy because it looks retrospectively at some of the things we have accomplished and how we have managed Fannie Mae and Freddie Mac (the Enterprises) in conservatorship to accomplish them.  By saying that this part of the speech is easy, however, I want to be careful not to suggest that all the decisions I will highlight were easy or noncontroversial when they were being considered.  It has been my experience that when decisions produce positive results down the road, we tend to forget how controversial or complicated these decisions might have been at the time they were made.   

The second part of the speech is difficult, both because it looks forward – something I have shown much less inclination to do up to this point in my time as Director of FHFA –  and because looking forward is inherently more difficult and almost always tends to generate more controversy.  After two full years as Director of FHFA, however, I think it’s timely for me to talk not only about our accomplishments, but also about some of the challenges and risks we face, some of which will surely become more difficult for us to control the longer the conservatorships continue.  While my primary responsibility as conservator may be to manage the Enterprises in the present as I have said on a number of occasions, I believe that I have an obligation, both in my role as conservator and in my role as regulator, to be frank and transparent about our challenges and risks.  By doing so, I hope these remarks will ignite some dialogue that could well be difficult, but I believe is also critically needed.