Today, the director of the Federal Housing Finance Agency (FHFA) warned of future losses to the U.S. Treasury arising from its exposure to Fannie Mae and Freddie Mac.
Who are Fannie and Freddie, and why do they matter for your taxpayer pockets? Here’s a quick primer/backgrounder.
“Fannie” (or “Fannie Mae”) stands for the “Federal National Mortgage Association.”
“Freddie” (or “Freddie Mac”) stands for the “Federal Home Loan Mortgage Corporation.”
Fannie and Freddie are government-chartered corporations, and are often called “Government Sponsored Enterprises” (GSEs) -- with publicly-traded common stock.
Fannie was created in 1938, and Freddie was created in 1970. They were both created by Acts of Congress. They have played significant roles in the mortgage finance market. Historically, they bought mortgage loans from banks. In the early 1980s, Fannie developed its first “mortgage-backed security,” which pooled loans it bought from originators into a security sold to investors.
This “securitization” role grew massively over time in the marketplace, in important part because Fannie and Freddie guaranteed mortgage interest and principal payments -- and as the market appreciated the apparent government backing for those guarantees by these publicly-traded corporations.
The market valued Fannie and Freddie’s common stock at over $40 billion apiece in mid-2006. But they both imploded in the 2007-2009 financial crisis, with their stocks falling almost 100%.
Fannie and Freddie are still publicly-traded corporations, even after extraordinary federal government interventions (“bailouts”) in the 2007-2009 crisis. Their stock symbols are “FNMA” and “FMCC,” respectively.
After the bailouts, the federal government owns nearly $100 billion worth of preferred stock and common stock warrants in Fannie and Freddie. How does our government account for these “investments?”
Under federal government accounting standards, certain “bailout entities” are specifically excluded from the federal government “reporting entity” in the Financial Statement of the U.S. Government, including Fannie and Freddie.
That means the U.S. government does not consolidate Fannie and Freddie in its balance sheet, for example. But the government does include the values of its investments in Fannie and Freddie in the balance sheet, and changes in the fair value of its investments in Fannie and Freddie are included in the Statement of Net Cost (the basic federal government income statement).
In 2014, the (estimated) fair value of these investments declined about $44 billion -- the largest factor in the Treasury Department’s $131 billion increase in net cost. The estimate of the change in fair value is subject to significant uncertainty, however, as the government uses projections and present value calculations in the absence of direct market prices, which are not available for these investments.
In its latest financial report, the U.S. government asserts that it “included disclosure of the relationship(s) with the bailed out entities and any actual or potential material costs or liabilities in the consolidated financial statements.” In footnote 9, in a subsection titled “Contingent Liability to GSEs,” the government reported that “Treasury estimated no probable future funding draws as of September 30, 2014 and 2013, and thereby accrued no contingent liability. During fiscal year 2013, the accrued contingent liability decreased by $9.0 billion.”
One question that arises is how the accrued contingent liability could have fallen to zero, even after a year when the government’s estimate of the fair value of its investments in Fannie and Freddie fell $44 billion.
This report of “no contingent liability” was in the latest financial report of the U.S. government covered the fiscal year 2014 (September) – over a year ago.
In a reminder that our government’s projections aren’t always perfect or even especially reliable, this morning (November 3, 2015), the director of the Federal Housing Finance Agency issued a statement that cautioned:
“Volatility in interest rates coupled with a capital buffer that will decline to zero in 2018 under the terms of the senior preferred stock purchase agreements with Treasury will likely make both Enterprises increasingly susceptible to the possibility of quarterly losses that could result in draws going forward.”
So, how far can they go, in a worst case scenario? The 2014 financial report of the U.S. government also cautioned that:
“… amounts will depend on numerous factors that are difficult to predict including, but not limited to, changes in government policy with respect to the GSEs, the business cycle, inflation, home prices, unemployment rates, interest rates, changes in housing preferences, home financing alternatives, availability of debt financing, market rates of guarantee fees, outcomes of loan refinancings and modifications, new housing programs, and other applicable factors. As of September 30, 2014 and 2013, the maximum remaining contractual commitment to the GSEs for the remaining life of the SPSPAs was $258.1 billion, which was established at a fixed amount as of December 31, 2012.”
In other words, it appears we are still on the hook for potentially $260 billion, at least in these two programs.
But Fannie and Freddie aren’t alone. For example, a related federal entity in the housing finance market is the Federal Housing Administration. The FHA insures mortgages – over $1 trillion worth. This program also exposes the federal government to risk of loss, in part because of the relationship of the program with Fannie and Freddie.
Will the U.S. government end up like AIG?