Severe Economic Downturn could Trigger GSE Bailout


The Federal Housing Finance Agency reports that the two
government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac might
together require government assistance
of as much as $157.3 billion in the
event of an extremely severe economic downturn. 
The figure comes as a result of a stress test mandated by the Dodd-Frank
Wall Street Reform and Consumer Protection Act for certain financial institutions
with more than $10 billion in assets, criteria which includes the two companies
which are in Federal conservatorship.

test, an annual requirement, is designed to determine whether an institution can
absorb losses as a result of hypothetical adverse economic conditions.  The Severely Adverse Scenario involves a deep
and protracted recession in which unemployment increases by 4 percentage points
from the beginning of the test horizon to a peak level of 10 percent by the middle
of 2016.  The real GDP declines by 4.5
percent from its beginning point to the end of 2015 and begins to recover in
2016.  Short-term interest rates remain
near zero though out the period and long-term rates drop significantly
to 1 percent in the 4th quarter of 2014.  Other conditions prevail such as a fall in
equity prices of 60 percent and of home prices by 25 percent.



For the GSEs the combined projected credit losses under the
scenario would be $43 billion, $24.9 billion for Fannie Mae and $18.1 billion
for Freddie Mac.  This represents 92
percent of their combined portfolios

Total projected comprehensive losses have a considerable range, between
$73.4 billion and $162.1 billion depending on whether or not the GSEs
reestablish a valuation allowance on deferred tax assets.

As of September 30, 2014 the GSEs have drawn a combined
$187.5 billion from the Treasury under the terms of the Senior Preferred Stock
Purchase Agreement (PSPA) negotiated when the they were placed into Federal
Conservatorship and renegotiated in 2012. 
The remaining commitment under the agreement ranges between $189.4
billion and $100.8 billion depending again on the treatment of deferred tax

Under the Severely Adverse Scenario the GSEs, which under
the terms of the renegotiated PSPA the GSEs are not permitted to rebuild
, would require incremental Treasury draws between $68.6 billion and
$157.3 billion depending again on the tax treatment.

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