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Wednesday, April 6, 2011

Fannie Mae’s and Freddie Mac’s Financial Problems

N. Eric Weiss
Specialist in Financial Economics

The continuing conservatorship of Fannie Mae and Freddie Mac at a time of uncertainty in the housing, mortgage, and financial markets has raised doubts about the future of these enterprises, which are chartered by Congress as government-sponsored enterprises (GSEs) and whose debts are widely believed to be implicitly guaranteed by the federal government.

In 2008, the Federal Housing Finance Agency (FHFA) replaced the Office of Federal Housing Enterprise Oversight (OFHEO) as the GSEs’ safety and soundness regulator and took them into conservatorship. OFHEO had 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. When Treasury responds to the GSEs’ request for additional funds for the fourth quarter of 2010, it will hold nearly $154 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 February 25, 2011, 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.

To date, the federal government has purchased, or contracted to purchase, nearly $154 billion in stock in the two companies. Together the 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 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.

Once Treasury’s support for Fannie Mae and Freddie Mac ends, sometime after 2012, the GSEs will be challenged to pay the 10% annual cash dividend contained in their contracts. The enterprises could instead pay a 12% annual senior preferred stock dividend indefinitely.

The 112
th Congress is likely to consider the future of the GSEs and ways to reduce the cost to the federal government.

Date of Report: March 25, 2011
Number of Pages: 25
Order Number: RL34661
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