The crusade to end the conservatorship of the formerly insolvent GSEs – Fannie and Freddie – and to return them back into capital markets without a government backstop following their 2008 nationalization, is almost over… but it won’t be cheap.
According to a Federal Housing Finance Agency (FHFA) rule finalized Wednesday which stipulates how much capital cushion the companies would have to retain against their assets as fully private entities (in order to weather the next crisis), Fannie Mae and Freddie Mac will be required to hold a combined $280 billions to protect against losses as independent companies.
According to Bloomberg, which first reported the capital buffer, completing the capital rule has been the top priority for FHFA Director Mark Calabria, who during his tenure has aggressively pushed a Trump administration goal of ending Fannie and Freddie’s 12-year-old conservatorships.
Of course, with Washington in flux, any plans for releasing the companies could be upended by Joe Biden’s presidential election win, as his incoming administration is expected to have a much different take on housing-finance policy, according to Bloomberg.
The federal government took control of the companies – who don’t make mortgages but rather buy them from lenders, securitize them and guarantee repayment of principal and interest to investors – during the 2008 financial crisis and bailed them out with around $187.5 billion as mortgage defaults mounted. Then as Bloomberg reminds us, after the crisis the FHFA was slow to develop plans to release Fannie and Freddie as Congress and two presidential administrations considered various proposals to reshape the companies or replace them with a new system, without reaching a conclusion.
The $280BN joint buffer is designed so that Fannie and Freddie could survive a 2008-like calamity without needing a new bailout (it is unclear how much more they would need to survive a crisis that will be far greater than to the Fed blowing the biggest asset bubble ever). Amusingly, critics of the proposal – read those who are long Fannie and Freddie stock – say it requires far too much capital and will end up raising mortgage costs.
In comments on the proposed rule, Fannie and Freddie both said they might have to increase fees if the rule were finalized. Fannie said it might have to raise fees 0.2 percentage point on average, while Freddie said fees might have to rise between 0.15 percentage point and 0.35 percentage point. A senior FHFA official on Wednesday said that estimates of how the rule could affect mortgage costs are too simplistic and said the agency believed that the new rule is good for borrowers through the economic cycle.
Whatever the implications, at least the framework is now set… if only until the next administration comes in and reset everything. It means that with rule now finalized, Fannie and Freddie will now turn to how and on what timeline the companies will be able to raise the hundreds of billions of dollars needed to meet the new requirements. According to Bloomberg, they will be expected to develop capital restoration plans, which could include some combination of retained earnings and massive public offerings that could begin as soon as next year.
Separately, the FHFA has also begun a push in earnest to amend Fannie’s and Freddie’s bailout agreements with the Treasury Department. The bailout agreements provide Fannie and Freddie with hundreds of billions of dollars in additional capital if they run into trouble, but also require them to send most of their profits to the Treasury above a certain threshold. For the companies to raise the capital needed to meet the new rule, the Treasury Department and the FHFA would need to remove that limit. The FHFA official said the agency wants to permanently end the sweep of profits to the Treasury, as do all those who are long Fannie and Freddie stock.
Fannie and Freddie shareholders also hope an amendment to the bailout agreements will somehow reduce the government’s massive ownership stake in Fannie and Freddie. In addition to warrants to acquire nearly 80% of the companies’ common stock, the government owns more than $200 billion in “senior” preferred stock that would make any future public offerings problematic.
Alas, despite the last-minute rush by Calabria to strike a last-minute amendment with outgoing Treasury Secretary Steven Mnuchin, it may not come fast enough at which point things go back to square one as the Biden administration is unlikely to share the goal of releasing the companies in the near term. As such the fate of the GSEs is now in the hand of Mnuchin: as Bloomberg notes, it is not clear if the former Goldman partner will prioritize finalizing such a complicated agreement in the two months he has left in office.