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Fannie and Freddie Capital Sank Closer to Zero in First Quarter, as Planned

For Fannie Mae and Freddie Mac, the first quarter of 2016 was nothing to cheer especially loudly about in terms of the bottom line but the companies reported being generally successful in stoking homeownership just the same.  And yet, they are gearing up for the day when they will be forced to come to taxpayers, hat-in-hand. That’s the way Treasury wants it.

On Tuesday Freddie Mac announced a net loss of $354 million for the first quarter of the year. The loss was due mostly to how decreases in interest rates affect Freddie’s derivative holdings and not a weakening housing market.  In fact, an accompanying statement from CEO Donald H. Layton confidently declared, “Freddie Mac’s first quarter business results continued to be strong, reflecting our transformation to be a more competitive company.” Fannie Mae, meanwhile, announced today quarterly profits of $1.1 billion. Of course, $919 million of that was snatched up by Treasury.

Indeed, both companies’ statements noted that the terms of the conservatorship, amended by the 2012 Net Worth Sweep that will whittle their capital to zero by 2018, make it inevitable that they will experience a negative net worth and have to draw from public funds.

This week’s earnings reports were eagerly anticipated. Many market watchers suspected the stage was set for a draw by Freddie or Fannie back in February when Federal Housing Finance Agency Director Mel Watt warned that D-day was looming. Watt’s deliberate candor about his concerns over dwindling rainy day capital made news but he was merely summarizing financial reality. Of course, the GSEs’ 2015 net income was a far cry from the companies’ historic 2013 earnings, when Fannie and Freddie posted record profits following the reversals of off-balance sheet losses that the government forced them to write down in the wake of the Great Recession. But the GSE business model clearly remains very healthy – slight income and profit declines and market fluctuations happen to the best of companies. Just ask Apple.

Of course, what Apple has going for it is that it gets to keep its earnings. By doing so it has created an ample capital buffer – $233 billion in cash and securities – far beyond ample, in fact.  Thus, even if iPhone sales slow, the company should be fine over the long term. It is remarkable how resilient companies can be when they are allowed to retain capital and function based on market principles.

In contrast, Freddie and Fannie are systematically depleted of capital, forced to accept lines of credits on impossible terms and trapped in a “short-term” conservatorship which is now in its eighth year. Over this period, Freddie has sent Treasury $98.2 billion, repaying taxpayers for $71.3 billion in emergency funds provided when conservatorship was created – plus $26.9 billion thanks to the Sweep. With its latest payment to Treasury, Fannie will have forked over $148.5 billion to Treasury – $32.4 billion more than what it was lent.

If Freddie had kept that $26.9 billion, Tuesday’s announcement would have been that a well-capitalized company posted modest losses reflecting derivative calculations. Not exactly a “stop-the-presses” development. If Fannie retained the nearly $1 billion it will turn over the Treasury, it would have been good news for shareholders and taxpayers alike.

Instead, we remain on a collision course concocted by Treasury. Administration officials have been simultaneously overt and covert with regard to this bizarre arrangement.  Treasury officials have made no apology for wanting to wind down the GSEs and replace them with a model based more on private capital. They have been less candid in explaining that “private capital” inevitably means big banks gaining a larger share of the mortgage finance market. And they have been nothing short of paranoid about revealing the fact that they saw the New Worth Sweep as a good way to hasten the end of the Fannie and Freddie era and pad the federal budget bottom line. Columnist George Will today eloquently sums up the embarrassing revelation in recently unsealed court documents.

For years we have decried Treasury’s deliberate policy of doing the reverse of what the law requires with regard to the conservatorship of these companies. We have warned repeatedly that taxpayers would be exposed to the GSEs’ financial losses so long as the companies are prohibited from recapitalizing. This week’s earnings reports reinforce the fact that this reality is closer on the horizon.