Four takeaways from deal to prop up GSEs


WASHINGTON — The announcement Thursday that Treasury Secretary Steven Mnuchin and Federal Housing Finance Agency Director Mel Watt agreed to let Fannie Mae and Freddie Mac each build a $3 billion capital buffer avoided a potential crisis.

Without this deal, Fannie and Freddie would have faced a scenario where they were going to have zero capital starting next year, and a draw on the Treasury by the cash-hungry government-sponsored enterprises would have been severe. Their funding needs were exacerbated by the tax reform legislation, which will significantly reduce the value of their deferred tax assets.

A draw is still possible, and Fannie and Freddie are not out of the woods yet. But the agreement to let them keep at least a portion of their capital will mitigate their funding needs and the effects of tax reform. Perhaps more importantly, an improvement in the GSEs’ financial situation puts the mortgage giants on better footing before they can be restructured through housing finance reform.

Fannie Mae building

Without the deal announced Thursday, Fannie Mae and Freddie Mac would have faced a scenario where they were going to have zero capital starting next year.

“You first have to stabilize the patient before you perform the surgery,” said Ed Mills, a policy analyst at Raymond James. “This keeps the patient stable for Congress to determine what kind of surgery they conduct to the housing finance market.”

Here are some key takeaways from the deal announced between Mnuchin and Watt.

Fannie and Freddie’s financial problems are too dire to ignore

Watt said as early as last February that Fannie and Freddie should be able to hold some capital in order to protect against a quarterly loss. The rhetoric picked up in recent months as Watt told Congress that he would consider suspending dividend payments to Treasury to address the GSEs’ capital needs.

Those dividend payments were part of a 2012 stock agreement with the government that was meant in fact to deplete Fannie and Freddie of their capital. This would ensure they could not be stood up again as quasi-private entities, and hopefully prod lawmakers to passing housing finance reform legislation.

However, in the five years since that agreement, Congress hasn’t been able to pass a bill and Fannie and Freddie were facing a scenario where they would have zero capital starting next year. The effects of a write-downs of deferred tax assets resulting from tax reform was only going to worsen the situation, forcing the two companies to draw on a $250 billion taxpayer line of credit.

The agreement helps momentum for a bill

Estimates vary on how significant the deferred tax asset write-down will be, but it is likely to be somewhere between $10 billion to $20 billion for the two mortgage companies combined. It is unclear whether Fannie and Freddie’s profits combined with the new additional buffer will be enough to prevent a draw.

Some had worried that the true impact of Fannie and Freddie needing a huge draw would be that their critics would use another bailout to stoke calls to eliminate the companies for good.

“I have some fears that there will be some that will overplay the draw from the tax assets to either kill Fannie and Freddie or use it as a crisis situation to force congressional action,” said Michael Calhoun, president at the Center for Responsible Lending.

The political rhetoric has proven to be a big distraction in efforts to reform the GSEs. The agreement may take that distraction off the table.

Mills said that the agreement makes it less likely that Fannie and Freddie are stood back up.

A number of groups have pushed for the GSEs to be recapitalized and released from government conservatorship. However, while the new arrangement will allow them to hold $3 billion, it also ensures that Watt will continue to send a quarterly dividend to Treasury.

“One of the key pieces for [recapitalizing the GSEs] is getting the next FHFA director shutting off the dividend,” said Mills.

Without an agreement, Watt and Mnuchin could have been headed toward a showdown, with Watt asserting that he had the authority to withhold the dividend as part his job as conservator. Mnuchin on the other hand has said that he expects Watt to continue to deliver the dividends, which can be used pad taxpayer coffers and pay for unrelated programs.

The new arrangement is a compromise.

“Establishing this defined $3 billion buffer is a measured response and will create enough cushion for general accounting losses, aside from the impacts resulting from the latest tax legislation,” said David Stevens, president and chief executive of the Mortgage Bankers Association. “This negotiated outcome is far better than the director taking unilateral action and should put to rest calls for indefinite retention of earnings.”

Small lenders are happy

Ron Haynie, senior vice president of mortgage finance policy for the Independent Community Bankers of America, said that, while a number of policymakers see a draw by Fannie and Freddie on the Treasury line of credit as a nonevent, that is not how small banks see the situation. Improving the financial standing of the GSEs removes some of the uncertainty around how they can still serve the mortgage market.

“People say they have this line of credit and it shouldn’t affect community banks, but what we don’t know is what we don’t know,” Haynie said. “Community banks, small lenders, they depend on” Fannie and Freddie.

He added that the risk still exists if the write-down on the deferred tax assets puts the GSEs in the red.

But industry representatives do not view the agreement as a total solution, and are still concerned about the effect of tax reform.

Glen Corso, executive director at the Community Mortgage Lenders of America, said, “It appears that the new tax legislation will require a write-down by each GSE that will exceed the agreed upon $3 billion capital buffer.

“We caution Congress that the write-downs driven by the tax legislation should not be used as an excuse to restrict the GSEs’ activities or curtail the availability of mortgage credit for American home buyers,” he said.

Critics of the GSEs hate the deal

House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has called for putting an end to Fannie and Freddie, and is one of the harshest critics of using taxpayer funds to back the GSEs. He swiftly opposed the new agreement.

“I’m very disappointed at FHFA and Treasury’s decision to roll back these vital taxpayer protections,” Hensarling said in a press release. “There is simply no good reason, policy or otherwise, why we should be putting the GSEs’ balance sheets ahead of the interest of taxpayers.”

Clifford Rossi, a professor at the University of Maryland business school who has held senior risk management positions at Citigroup, Washington Mutual, Countrywide, Freddie Mac and Fannie Mae said a $3 billion buffer is hardly enough to protect taxpayers.

“Capital requirements imposed on both agencies were clearly well-undercapitalized at the time of the crisis and $3 billion isn’t even close to what they had at the time,” Rossi said. “It just shows the lack of sound public policy in housing finance these days.”

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