Awaiting the Verdict on Fannie Mae and Freddie Mac
By Sang Hyun ParkPublished March 10, 2015When the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship, policymakers seemed to have a clear plan about what to do with them. Following the cataclysmic 2008 subprime mortgage crisis, the idea was to wind them down, replacing the government-sponsored enterprises (GSEs) with a new federal insurance system. A bill proposed in Senate last year proposed to liquidate the two enterprises, allowing the private sector to gain a greater share of the risk of mortgage losses.
Yet, the plan has been foiled by an unexpected development: Fannie and Freddie are thriving once again. In fact, they are doing better now than ever before. In addition to paying back the $188 billion bailout to the Treasury, the GSEs have grown hugely profitable. The Economist reported in February that the mortgage-insurance giants were generating even bigger profits than before the crisis.
Even with the recent decline in profits, the pair's overall growth in earnings remains largely undisputed. Fannie Mae's fourth quarter earnings did fall by 66% from $6.5 billion in 2013 to $1.3 billion, but such declining profits have only prompted the FHFA and policymakers to propose improvements to the GSEs' operations, such as adopting a stricter criteria for minimum financial eligibility requirements. Fannie and Freddie's books indicate consistent earnings overall since the federal takeover, showing that the declining profits do not reflect trouble in the GSEs' mortgage business. Fannie's net interest income in the fourth quarter was $5.1 billion in the fourth quarter, a marked increase from the $4.9 billion earned in the same period of 2013. Fannie Mae CEO Tim Mayopoulos has reported that it expects to remain profitable on a yearly basis "for the foreseeable future."
With the GSEs' return to profitability, the question of whether or not to wind them down has turned into a contentious political issue. On one hand, a majority of Republicans have been eager to legislate the process. President Obama has also endorsed the plan as a way of giving private capital a bigger role in the mortgage market and creating more security for taxpayers. The wind-down plan has, however, received sparse support from Democrats. After the Johnson-Crapo bill in Senate last year failed to pass, Congress has been at a gridlock on the issue. With the Banking Committee Democrats' 6-6 split on the bill, Senate Majority Leader Harry Reid chose to leave aside the divisive issue until after the election year.
At the heart of the matter is the GSEs' dual identity as both private and public entities. While originally founded as public agencies, their operations with mortgage-backed securities have been private in nature. The legal warfare that sparked between taxpayers and a shareholder following the "third amendment" highlights this controversy. In July 2013, the Faireholme Fund sued the government for the amendment and its claim over the profits of the GSEs. Initially, in exchange for the taxpayer-funded bailout, the GSEs agreed to pay the Treasury through dividend payments. When this turned out to be unsuccessful, the government, through the third amendment, directed the Treasury to gain a "net-worth-sweep" of the pair's net income instead. Fairholme Fund's lawsuit was one a wave of lawsuits by investors who protested the amendment, which they believed to be an unlawful seizure of private property.
The question of its status as either a private or public enterprise will determine what policymakers will ultimately do with the mortgage-insurance providers. It is still unclear whether those who advocate winding down the GSEs intend to liquidate or privatize them. If there is any indication of what winding down will mean for Fannie and Freddie, however, it is the historical example of Sallie Mae. The student loan provider, which had also been a GSE, was wound down from 1997 to 2004. By the end of the process, Sallie Mae had become a fully private-sector company. As a result of the privatization of its operations, its business grew, with its stock price appreciating 300% over the 5-year wind down period. It was clear to see that its privatization benefitted shareholders.
In any case, the coming 2016 Presidential Election is expected to seal the fate of the two mortgage-insurance giants. Meanwhile, the government and taxpayers will likely enjoy rising dividends from the GSEs as they continue to churn higher profits.