New Agreement Allows GSEs to Retain Additional Earnings

Written By: Joel Palmer, Op-Ed Writer

A potential next step toward removing Fannie Mae and Freddie Mac from conservatorship was agreed upon last week.

The Treasury Department and the Federal Housing Finance Agency (FHFA) will now permit Fannie and Freddie to retain earnings in excess of the $3 billion capital reserves currently permitted by their preferred stock purchase agreements (PSPAs).

Under the modifications announced last week, Fannie Mae can retain up to $25 billion in capital, while Freddie Mac will be permitted to maintain capital reserves of $20 billion.

The announcement came about a month after Treasury released its plan to reform the housing finance system, which included a recommendation to enable the GSEs to retain more capital.

“These modifications are an important step toward implementing Treasury’s recommended reforms that will define a limited role for the federal government in the housing finance system and protect taxpayers against future bailouts,” said U.S. Treasury Secretary Steven T. Mnuchin.

FHFA Director Mark Calabria has previously stated that getting the GSEs out of conservatorship will be driven by their ability to raise capital.

Increasing capital levels has been challenging for Fannie and Freddie since they entered conservatorship because their profits have been sent to the U.S. Treasury since 2012. Through the second quarter of 2019, Fannie has paid $181.4 billion in dividends to Treasury. Freddie’s cumulative payments to date total $119.7 billion.

Even with the ability to retain more capital, it may take a few years for the GSEs to reach the new limits. Fannie Mae reported second quarter 2019 net income of $3.4 billion, up from $2.4 billion for the first quarter of this year. Freddie Mac’s second quarter income was $1.8 billion, up slightly from the previous quarter.

To compensate Treasury for the dividends it will no longer receive, Treasury’s liquidation preferences for its Fannie Mae and Freddie Mac preferred stock will gradually increase by the amount of the additional capital reserves until the liquidation preferences increase by $22 billion for Fannie Mae and $17 billion for Freddie Mac.

“The Enterprises are leveraged nearly 1,000-to-one, ensuring they would fail during an economic downturn – exposing taxpayers once again. This letter agreement between Treasury and FHFA, which allows the Enterprises to retain capital of up to $45 billion combined, is an important milestone on the path to reform,” said Calabria.

An additional amendment to the PSPAs was also negotiated that would include adopting covenants consistent with recommendations including the housing finance reform plan. The plan recommended that Treasury and FHFA develop recapitalization plans for Fannie Mae and Freddie Mac after identifying and assessing the full range of strategic options. Subsequent amendments to the PSPAs may be appropriate to facilitate the implementation of any eventual recapitalization plans, according to the statement.

“FHFA commits to working with Treasury in the coming months to amend the share agreements and further advance broader housing finance reform. These reform goals include limiting the government’s role in housing finance, increasing marketplace competition, focusing on affordable housing, and sustainable homeownership. The status quo is not an option. Now is the time to act.”

The National Association of Realtors supported the recapitalization announcement.

“We urge Congress and the administration to work together toward a consensus that will create a housing finance system that protects taxpayers, supports homeownership and maximizes competition. The private utility model Realtors proposed earlier this year outlines the best possible path forward for the GSEs, and we will continue to work closely with policymakers to shape positive, pragmatic system reforms.”

About the Author

As an NAMU® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning.

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