 The official reason for uncapping spending to aid these two central players in U.S. housing was to give investors confidence and provide flexibility to try to bring an end to the housing crisis, reports the Wall Street Journal. AnalysisOnline looks back at a report on how conservatorship of Fannie Mae and Freddie Mac was supposed to work and finds that removing the cap is a gamble that could go sour.
Before the Christmas Eve action to remove the limits on how much could be spent to aid the two government-supported enterprises (GSEs), Fannie Mae and Freddie Mac had received a combined $111 billion, less than one-third of the combined $400 billion limit.
So why the urgency at the U.S. Treasury Department on Christmas Eve to remove the cap (other than, as several media outlets are reporting, the timing enabled Treasury to bypass Congressional approval and avoid heavy scrutiny by Americans who were otherwise occupied with holiday activities)?
Here is what the U.S. Treasury Department’s news release on December 24 said:
“At the time the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship in September 2008, Treasury established Preferred Stock Purchase Agreements (PSPAs) to ensure that each firm maintained a positive net worth. Treasury is now amending the PSPAs to allow the cap on Treasury's funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years. At the conclusion of the three year period, the remaining commitment will then be fully available to be drawn per the terms of the agreements.
“Neither firm is near the $200 billion per institution limit established under the PSPAs. Total funding provided under these agreements through the third quarter has been $51 billion to Freddie Mac and $60 billion to Fannie Mae. The amendments to these agreements announced today should leave no uncertainty about the Treasury's commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.
“The PSPAs also cap the size of the retained mortgage portfolios and require that the portfolios are reduced over time. Treasury is also amending the PSPAs to provide Fannie Mae and Freddie Mac with some additional flexibility to meet the requirement to reduce their portfolios. The portfolio reduction requirement for 2010 and after will be applied to the maximum allowable size of the portfolios – or $900 billion per institution – rather than the actual size of the portfolio at the end of 2009.”
GSEs: Troubled Then, Troubled Now
The two GSEs are acknowledged as having a strategic role in the growth of the subprime mortgage mess that, by most accounts, launched the housing crisis – and they have grown substantially in the last couple of years.
Here is how their performance has been described:
“In early November, Fannie Mae announced a third-quarter loss of $19 billion, making $102 billion in losses over the last two years….Freddie Mac lost ‘only’ $6.3 billion in the third quarter, but overall has been an even bigger financial black hole, dropping $121 billion over the last 14 months.” (Wall Street Journal)
and
“The companies have lost a combined $188.4 billion in the past nine quarters. The federal government now holds almost 80 percent of the equity in each of the entities.” (Bloomberg)
When the federal government conducted the takeover in September 2008 and put in place new chief executive officers, the GSEs were in crisis mode and, had they been purely private firms, they likely would have failed, according to observers noted in a Congressional Research Service report. The value of their assets had fallen precipitously, but the debt associated with those assets remained, and raising capital was all but impossible.
Fast-forward to a Christmas Day article in the Los Angeles Times and discover U.S. taxpayers have already paid almost $400 billion to prop up the two GSEs; and, by the way, the new CEOs of Fannie Mae and Freddie Mac could get $6 million a year in pay in 2009 and 2010.
The Congressional Research Service report notes that the legislation that enabled the takeover of Fannie Mae and Freddie Mac – The Housing and Economic Recovery Act of 2008 – gave a privilege to the conservatorship of the GSEs that is not part of how insolvent banks are treated. That is, the new agency created and given authority over the GSEs (the Federal Housing Finance Agency, or FHFA) “… is not bound by the bank regulators’ mandate that failing institutions be resolve at the lowest possible cost.”
Now, with the cap removed on how much taxpayer funding can be directed to prop up the two GSEs, and no real accountability for how that is done (no mandate it be done at least possible cost), plus the fact that Fannie Mae and Freddie Mac are financing as much as 75 percent of new U.S. mortgages (see FDIC Chairman Sheila Barr’s statement in Bloomberg), it appears taxpayers are being pushed even further out on a limb in a housing scenario that could rival earlier difficulties.
The signs that the housing crisis might be improving are flitting at best – here one day, and gone the next. If housing and financial stability don’t return genuinely, consistently, and quickly, the Congressional Research Report says taxpayers could be placed at much higher risk:
“If housing values continue to fall for an extended period, the taxpayer may be required to make good on substantial losses to Fannie and Freddie’s investment portfolios and guarantee obligations.”
(The two GSEs buy home mortgages from the original lenders and repackage them as mortgage-backed securities and sell them or hold them in their investment portfolios.)
Writing in Forbes, Cato Institute Senior Fellow Doug Bandow illustrates that taxpayers are called on to fund increasing amounts of “federal largesse,” while the amount of accountability by the federal agencies and even new homeowners is small. (The article notes that FHA loans require as little as 3.5 percent down and Congress is seeking to raise the loan limit from just under $730,000.)
The tenuous nature of the residential housing sector as “Washington appears bound to repeat its past mistakes” is not the only concern, however, says Bandow. “What will the politicians do if the commercial real estate market collapses, as some analysts predict? Fannie and Freddie again are at risk, having jumped into apartment lending just as the commercial real estate market peaked,” he notes.
(For a discussion of the problems facing the commercial real estate sector and what it means in terms of general financial instability and job loss, see AOH, July 23, 2009, “Failing Health of Commercial Property.”)
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