Fannie Mae and Freddie Mac will be allowed to boost their capital by billions of dollars to protect against potential losses, a key step in the Trump administration’s push to free the mortgage giants from U.S. control.
Fannie will be permitted to retain earnings until its capital buffer hits $25 billion, while Freddie will be allowed to hold $20 billion, the Treasury Department and the Federal Housing Finance Agency announced Monday. Last year, Fannie reported net income of $16 billion and Freddie made $9.2 billion, signaling it could take more than a year for the companies to reach the administration’s new goal.
Treasury and FHFA, Fannie and Freddie’s regulator, also committed to making more changes to the bailout agreements that were struck after the companies were rescued with taxpayer funds at the height of the 2008 financial crisis.
The agencies said they intend to make additional tweaks to Fannie and Freddie’s capital structures, as well. The moves are all part of an effort -- outlined in a plan released by Treasury earlier this month -- to end the companies’ decade long conservatorships and return them to the private market.
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“These modifications are an important step toward implementing Treasury’s recommended reforms that will define a limited role for the federal government in the housing finance system and protect taxpayers against future bailouts,” Treasury Secretary Steven Mnuchin said in a statement.
The change, which has been telegraphed by FHFA Director Mark Calabria and Mnuchin for weeks, marks one of the biggest changes for Fannie and Freddie since they were made wards of the state. Under the companies’ current bailout agreements, they are restricted from holding more than $3 billion in capital apiece, much less than they would need to survive outside government control. Instead of retaining earnings, they send their profits each quarter to the Treasury -- a process known as the net worth sweep.
But even at the levels outlined in Monday’s statement, Fannie and Freddie would still be far short of the capital cushions that most everyone agrees are required. Calabria and Mnuchin have both said the companies will need to raise private capital, potentially through a share sale. One way to interpret Monday’s announcement is as a suspension of the net worth sweep.
With much still to be sorted out, it’s unclear how soon hedge funds and other investors that own Fannie and Freddie stock might make windfalls on their stakes. And if a Democrat beats President Donald Trump in the 2020 election next November, Calabria and Mnuchin’s plans would likely be scrapped.
‘Significant Challenges’
“There are still some significant challenges to recapitalization," KBW analyst Brian Gardner said in a note earlier this month. “Recapitalization is unlikely to happen until after the 2020 election and then it will obviously be dependent to a large degree on the outcome of the election."
Still, Fannie and Freddie shares have rallied this year on Wall Street optimism that the Trump administration is making progress.
Fannie and Freddie don’t make loans. Instead they keep the mortgage market humming by buying loans from banks and other lenders and packaging them into securities. Bond investors consider the companies’ mortgage securities to be extremely safe because they have guarantees in case homebuyers default on their loans. The process provides liquidity for home purchases and keeps borrowing rates low.
Read More: Fannie and Freddie Died But Were Reborn, Profitably
The government took control of Fannie and Freddie when the housing market tanked in 2008, eventually injecting them with more than $187 billion. Their bailout agreements originally called for Fannie and Freddie to pay 10% dividends each quarter to the Treasury, but in 2012 the government changed the terms to sweep nearly all of the companies’ profits. In 2017, Treasury and FHFA amended that agreement to allow the companies to retain $3 billion in earnings apiece.
Under the agreement announced Monday, the amount of a senior preferred stock of Fannie and Freddie that is owned by Treasury will increase by $22 billion and $17 billion respectively, according to the statement.
The change announced Monday in some way kicks the can down the road until FHFA and Treasury are prepared make more sweeping changes. Calabria has indicated that the process of ending the companies’ conservatorships will take some time. In a Bloomberg Television interview earlier this month, he predicted that the companies probably won’t be ready to seek private capital until early 2021.
“The enterprises are leveraged nearly 1,000-to-1, ensuring they would fail during an economic downturn -- exposing taxpayers once again,” Calabria said in a Monday statement. The revised agreement with Treasury is “an important milestone on the path to reform.”
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