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Tuesday, December 14, 2010

Fannie Mae’s and Freddie Mac’s Financial Problems

N. Eric Weiss
Specialist in Financial Economics

The conservatorship of Fannie Mae and Freddie Mac raises questions about the impact of these government-sponsored enterprises (GSEs) on the housing and finance markets and their ability to return to financial viability. To date, the federal government has purchased more than $148 billion in stock in the two companies, with pending requests from Fannie Mae to purchase an additional $2.5 billion and from Freddie Mac for $100 million. Once these transactions are completed, the Treasury will hold $152.8 billion in senior preferred stock. Both companies are required under terms of the federal support to pay the government dividends of more than $15 billion annually (10% of the support). Housing, mortgage, and even general financial markets remain in an unprecedented situation.

Estimates of the total cost to the federal government use different baselines and vary widely. The Federal Housing Finance Agency (FHFA) estimates that Treasury is likely to purchase $221 billion-$363 billion of senior preferred stock by the end of 2013. The Congressional Budget Office estimates the budget cost for 2011-2020 to be $53 billion. Standard & Poor’s has estimated the cost at $280 billion plus $405 billion to create a replacement system.

FHFA placed Fannie Mae and Freddie Mac into conservatorship after turmoil in the housing, mortgage, and financial markets raised doubts about the future of these enterprises, which are chartered by Congress as GSEs and whose debts are widely believed to be implicitly guaranteed by the federal government. The FHFA replaced the Office of Federal Housing Enterprise Oversight (OFHEO) as the GSEs’ safety and soundness regulator. OFHEO repeatedly assured investors that Fannie and Freddie had adequate capital, but as highly leveraged financial intermediaries, Fannie Mae and Freddie Mac had limited capital to cushion themselves against losses.

The Treasury agreed to buy mortgage-backed securities (MBSs) from the GSEs and to raise funds for them. Initially, each GSE gave Treasury $1 billion in senior preferred stock and warrants to acquire, at nominal cost, 80% of each GSE. Treasury responds to the GSEs request for additional funds for the third quarter of 2010, it will hold nearly $153 billion of preferred stock in the two GSEs. Treasury has agreed to invest whatever is required to maintain GSE solvency through calendar year 2012. Now the formerly implicit guarantee is nearly explicit.

In addition to Treasury’s purchases of senior preferred stock, the Federal Reserve (Fed) has purchased GSE bonds and MBSs. According to a November 9, 2010, FHFA report, together the Fed and Treasury have purchased $1,356.7 billion in MBSs; these purchase programs terminated at the end of the first quarter of 2010.

Date of Report: December 3, 2010
Number of Pages: 24
Order Number: RL34661
Price: $29.95

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