The U.S. Treasury on Friday revamped the bailout of Fannie Mae and Freddie Mac to curb chances the giant mortgage finance firms could emerge from government control as the powerful, profit-driven corporations they once were.
The Treasury said it would require the companies, whose massive losses threatened the financial system after the housing bubble burst, to shrink their investment portfolios more quickly and turn over any profits to taxpayers.
Under the previous bailout terms, the companies, which buy mortgages from lenders and repackage them as securities for investors, were required to make a 10-per-cent dividend payment to the Treasury. At times, they have had to borrow from Treasury just to return the dividends. Now, they simply won’t be able to retain any profits.
Fannie Mae and Freddie Mac were seized by the government at their height of the financial crisis in 2008 as mortgage losses threatened their solvency. Since then, they have drawn a total of $188-billion (U.S.) in taxpayer funds to stay afloat, while paying more than $45-billion in dividends.
At the start of next year, the Treasury’s unlimited support for the companies will expire. After Dec. 31, Fannie Mae’s bailout funds will be capped at $125-billion and Freddie Mac will have a limit of $149-billion.
This has raised concerns among investors who buy their debt, a worry eased by the new terms.
“The market’s worry is that Fannie and Freddie will exhaust this Treasury capital and default on bond payments,” the Washington Research Group said in a note to clients. “Just the fear of this could drive up their borrowing costs, which would require them to seek government capital more quickly.”
The announcement hit preferred shares of the two firms, driving them down by more than 70 per cent in heavy trading, as investors saw the plan as undercutting their ability to ever emerge from government conservatorship as profitable companies. Their common shares also fell.
Their corporate debt, however, rallied as the new policy alleviated the need for Fannie Mae and Freddie Mac to borrow from the government just to make dividend payments, putting them in better position to service their debt.
“You fixed the major flaw in the initial agreement,” said Jim Vogel, interest rate strategist at FTN Financial in Memphis, Tennessee.
With the housing market showing signs of improvement and Fannie Mae and Freddie Mac reducing their portfolios of loans with poor credit quality, the government-owned companies posted strong profits in the second quarter of this year.
The Treasury said the altered bailout terms would ensure that “every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms.”
Although the Treasury said the changes would accelerate plans to eventually shut the companies down, the announcement did little to address how that might be achieved or how the government’s footprint in the mortgage finance market might shrink. Along with the Federal Housing Administration, Fannie Mae and Freddie Mac finance nine out of every 10 new home loans.
Early last year, the administration unveiled a policy paper that outlined three options to reshape the U.S. housing finance system, but it has yet to provide further details.
While Republicans and Democrats agree on the need to reduce the government’s role in housing finance, they disagree on how drastically and Congress has yet to take action.
As part of the new bailout terms, Fannie Mae and Freddie Mac will be required to reduce their investment portfolios at an annual rate of 15 per cent instead of the previous 10 per cent. That will put them on track to each cut their portfolios to a targeted $250-billion in 2018, four years earlier than previously scheduled, the Treasury said.
Fannie Mae’s investment portfolio, valued at $673-billion as of the second quarter, holds distressed loans and mostly mortgages that were originated before 2008. Freddie Mac’s investment portfolio was valued at $581-billion as of June.
During the years of the housing boom, their portfolios generated enormous profits.