Monday, November 28, 2011
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 third quarter of 2011, it will hold nearly $186 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 FHFA, the Fed and Treasury together have purchased $1,356.7 billion in MBSs; these purchase programs terminated at the end of the first quarter of 2010. On September 21, 2011, the Fed decided to reinvest MBS principal repayments in new MBS.
Under terms of the federal government’s purchase of their preferred stock, the enterprises are required to pay the government dividends of nearly $19 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 $220 billion-$311 billion of senior preferred stock by the end of 2014. 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.
In August 2011, Standard & Poor’s downgraded the debt of the federal government, Fannie Mae, and Freddie Mac. To date, there is no evidence that this has increased mortgage interest rates, but the impact may take longer to occur or to be detected.
The 112th Congress is likely to consider the future of the GSEs and ways to reduce the cost to the federal government.
Date of Report: November 17, 2011
Number of Pages: 27
Order Number: RL34661
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