It News: U.S. Treasury revamps Fannie, Freddie support deal

U.S. Treasury revamps Fannie, Freddie support deal

Aug. 17, 2012
By Nick Timiraos

WASHINGTON--The U.S. Treasury Department will revamp the terms of its nearly four-year-old financial backing of Fannie Mae FNMA -1.67% and Freddie Mac FMCC 0.00% in a bid to allay investor concerns that the companies could one day exhaust their federal lifelines.

The renegotiated agreements, announced Friday, will change the way the firms pay the government and are designed to ensure that that Fannie and Freddie aren't revived as private companies.

"We are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac, while continuing to support the necessary process of repair and recovery in the housing market," said Michael Stegman, a Treasury official overseeing housing finance policy "We are committed to putting in place measures right now that support continued access to mortgage credit for American families, promote a responsible transition and protect taxpayer interests."

Fannie and Freddie buy up mortgages and package them into securities sold with a guarantee that investors will be paid even when borrowers default. The government's support of both companies has been critical for keeping mortgage markets functioning. It has allowed consumers to obtain mortgages through the crisis, many of them at near-record-low rates as the Federal Reserve has embarked on several rounds of bond buying.

Currently, Fannie and Freddie make 10% dividend payments to the Treasury every quarter, which has forced them to borrow money from the government to repay the government in periods where they don't turn a large profit. Under the new arrangement between Treasury and the companies' federal regulator, all profits that the firms make in any quarter would be taken by the government as a dividend payment. The government wouldn't require such payments in periods where the firms run a loss.

The revised terms would also accelerate the downsizing of the firms' mortgage portfolios, these people said. The firms will have to shrink those portfolios by 15% annually beginning next year compared with the 10% annual reduction currently required. That means the firms' portfolios, which can be no larger than $650 billion each at the end of the year, will fall to the final cap of $250 million by 2018, four years earlier than previously scheduled.

The Bush administration took over the companies in September 2008 through a legal process known as conservatorship as ballooning losses wiped out thin capital reserves. The Treasury has injected nearly $188 billion into the companies, taking in exchange senior preferred shares of stock that pay the 10% dividend. Fannie and Freddie have paid nearly $46 billion to the government through those dividends.

The changes are designed to avoid the prospect that Fannie and Freddie could one day exhaust their Treasury support simply because they might not generate enough profit to pay back those dividends. They will also prevent the companies from rebuilding capital, which should tamp down any hopes or fears that the firms would one day re-emerge from conservatorship in their old forms.

Any losses generated by the Treasury dividend payments haven't been a concern until now, in part, because the Treasury in 2009 amended its agreements with the firms to provide unlimited support through 2012. Previously, the companies had been provided up to $200 billion each in support from the government.

At the end of this year, the existing agreements return the companies to a limited amount of support, which adds up to $200 billion less any funds that had been injected through 2009. The Treasury will be able to inject up to $125 billion into Fannie and $150 billion into Freddie.

While the companies have turned profits in recent quarters, they have had to pay such large dividend payments to the Treasury every year--nearly $19 billion between the two firms--that they continue to borrow money from the Treasury in certain periods, even in those where they run a small profit. Requiring larger injections from the Treasury, in turn, increases future dividend payments.

The changes are coming at a time when Fannie and Freddie appear to have stemmed huge losses that accelerated in 2008, when they were taken over by the U.S. government through conservatorship. Those losses continued until late last year as home prices declined. Fannie has turned a profit in both quarters so far this year totaling $7.8 billion amid stabilizing home prices and fewer mortgage delinquencies. It had previously posted losses in 17 of 18 quarters.

The revised agreements don't suggest any broad shift in the government's approach to the companies. While the Obama administration hasn't made any major effort to overhaul the companies, it has steadfastly insisted that the companies would have whatever support was needed to ensure they could repay bondholders.