What does the future hold for Fannie and Freddie?
Written By: Joel Palmer, Op-Ed Writer
Following another profitable quarter and strong results for 2016, Fannie Mae and Freddie Mac seem like their strong enough to survive on their own without government conservatorship.
But despite their healthy financials, the future is both organizations is still up in the air. They may or may not be released from government ownership. They may or may not be easing lending requirements.
Fannie Mae and Freddie Mac were formed after the Great Depression to help banks with liquidity and financing to make loans to would-be homebuyers. The idea was to purchase mortgages from banks and sell them to investors, which freed up bank funds to issue more home loans.
When the 2008 financial crisis hit, the combination of plummeting home prices and rising mortgage defaults put at risk mortgage-backed securities backed by Fannie and Freddie. This required a $188 billion bailout from the federal government, which took over ownership.
Since then, Fannie and Freddie have seemingly recovered. With the exception of a $354 million loss reported by Freddie Mac in the first quarter of last year, the GSEs have reported profits for each quarter since 2012. That includes the most recently completed quarter in which both entities booked net income of around $5 billion. Both had strong full-year results as well: Fannie reported annual net income for 2016 of $12.3 billion, while Freddie reported annual income of $7.8 billion.
Under the conservatorship arrangement, those profits are paid to the U.S. Treasury in the form of dividends. Including the most recent dividend, Fannie and Freddie have paid a total of $266 billion in dividends, about $78 billion more than what Treasury spent to bail them out.
At the end of the fourth quarter Fannie Mae's net worth was $6.1 billion and Freddie Mac's was $5.1 billion.
However, The agreements with Treasury limit how much of its net worth Fannie Mae can retain, an amount that falls to zero in 2018. Fannie is also unable to “rebuild our capital position or pay dividends or other distributions to stockholders other than Treasury. Our senior preferred stock purchase agreement with Treasury also includes covenants that significantly restrict our business activities.” These provisions leave Fannie Mae and Freddie Mac vulnerable to a future downturn.
The Trump Administration has strongly indicated a desire to end government controls of the GSEs. Treasury Secretary Steven Mnuchin said after being nominated for his current post that ending the arrangement was a top 10 priority and that his department would end government control of Fannie Mae and Freddie Mac once officials can ensure “that when they are restructured, they are absolutely safe and don’t get taken over again.”
Some in the industry, however, are concerned about bringing Fannie and Freddie out of conservatorship.
Some caution that removing the GSEs from government control would lead to higher mortgage rates. The reason: private investors will not want to take on the risk that the federal government has assumed for mortgage-backed securities.
Mortgage rates have already ticked upward. Combined with rising home values and strict borrowing requirements, the cost of home ownership is escalating. So it may not be politically wise to add to that cost by privatizing the GSEs, says the argument against privatization.
That’s not the only risk, according to Moody’s Investors Services. The firm recently warned that ending government ownership of Fannie and Freddie would cost hundreds of billions of dollars and be a negative for bond investors as well.
One concern is the amount of capital the two entities can currently maintain. As previously stated, the capital buffers of Fannie and Freddie are set to be drawn down to $600 million this year and eventually to $0 in 2018, which is part of the government’s purchase agreement.
But as Moody’s notes, operating outside conservatorship would require significantly more capital to ensure “continued fluidity of the mortgage market.”
There’s also the issue of debt, with both entities having accumulated over $350 billion each.
“Privatization would be credit negative for the GSEs because it increases the risk of funding disruptions owing to the many questions about how privatization would occur given the amount of debt the GSEs must refinance,” reads the Moody’s report.
Furthermore, Fannie and Freddie have $4.6 trillion of mortgage-backed securities outstanding, close to 25 percent of the nation’s GDP.
“Disruptions in their ability to issue debt, materially higher debt issuing costs or a decline in mortgage-backed securities pricing would negatively affect US housing and the US economy,” the reports states.
About the Author
As an NAMU® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.
