Finance & economics | Fannie Mae and Freddie Mac

A funny form of conservation

The government may soon need to rescue America’s mortgage giants again

|Washington, DC

TEMPORARY solutions have a way of becoming permanent. The fate of Fannie Mae and Freddie Mac, the two “government-sponsored enterprises” (GSEs) that stand behind much of America’s housing market, is a case in point. The GSEs, which buy American mortgages from banks and other originators, bundle them into securities and resell them to investors with a guarantee, are stuck in a technocratic no-man’s land. Their status has not yet been normalised after their first bail-out, but they may soon require a second. If they do, the administration of Barack Obama, which has been running them since 2009, will be largely responsible.

Fannie and Freddie were tethered to America’s housing market when it fell off a cliff in 2008. The GSEs faced a double impact: they had to cough up to honour their guarantees, while also suffering losses on their own big portfolios of mortgage-backed securities. The firms had an odd ownership structure, with a public charter, and thus an implicit government guarantee, but private shareholders. To stop them collapsing, which would have further hurt both the housing market and the financial system, the government injected $188 billion and placed them into conservatorship—a form of government control. A further backstop, currently $258 billion, has yet to be invoked. All in all, the rescues were the largest in financial history.

Since 2012, however, in an effort to claw back the bail-out, the Treasury has hoovered up all of the GSEs’ profits—much to the dismay of their shareholders, whose rights have been suspended, prompting some of them to sue the government. Altogether, the taxpayer has recouped $239 billion from the firms—more than the cost of the rescue, but not yet enough to compensate for the risk taxpayers have assumed, says Edward Pinto of the American Enterprise Institute, a think-tank.

These profits, though, are not guaranteed. On November 3rd, Freddie Mac announced that it had lost $475m in the third quarter of 2015—its first loss since 2011. Write-downs on the value of interest-rate derivatives, which both GSEs use to hedge their risks, were to blame.

Such paper losses would be no cause for worry, were it not for the firms’ thinning capital cushions. Under the terms the government imposed in 2012, GSEs must reduce their capital by $600m a year, remitting those funds to the taxpayer in addition to any profits. As a result, by 2018, the GSEs will have no capital whatsoever. Even a single paper loss will leave them insolvent.

At the same time, the GSEs are becoming less profitable. Their portfolios of mortgage-backed securities, although lucrative in good times, look a lot like taxpayer-financed speculation. Under the terms of the bail-out, they must run them down and focus only on issuing guarantees.

A second bail-out would not be proof of mismanagement at the GSEs; it would be necessary only because the Treasury has been feasting on their capital. But it might provide fresh political impetus for reform. In the aftermath of the crisis there was widespread agreement that the GSEs needed to be replaced or overhauled, says Jim Parrott, a former White House adviser now at the Urban Institute, a think-tank. But Congress has yet to settle on a new arrangement (a recent effort stalled in the Senate last year). Rumours that the administration had given up waiting and was about to release the firms from conservatorship caused their share prices to spike in October, before Jack Lew, the treasury secretary, insisted that nothing had changed.

Getting the government out of the housing market will be difficult. Every time Fannie or Freddie guarantees a new long-term mortgage, the Treasury’s backstop is in effect renewed for 30 years. Last year Fannie and Freddie stood behind half of new mortgage lending, according to Inside Mortgage Finance, a newsletter (other government agencies guaranteed a further 20% of lending). Politicians who withdraw this support, or raise its price, risk being blamed for any subsequent housing slowdown. In any case, most want to retain a government guarantee of some sort; many Democrats, especially, want the agencies to boost lending to minority groups.

Congress has been able to agree on one thing: on November 16th the House passed a Senate bill to cap the salaries of the GSEs’ chief executives at $600,000. That does not address the problem at hand—but taxpayers will doubtless cheer anyway.

This article appeared in the Finance & economics section of the print edition under the headline "A funny form of conservation"

How to fight back

From the November 21st 2015 edition

Discover stories from this section and more in the list of contents

Explore the edition

Discover more

China’s banks have a bad-debt problem

As is becoming increasingly obvious

Which country will be last to escape inflation?

A new dividing line in the global fight


How the “Magnificent Seven” misleads

Forget the supergroup of stockmarket darlings