Fannie and Freddie: To Be or Not to Be?
Sam Chandan Nov. 12, 2009, 7:05 p.m.
Fannie Mae reported its third-quarter financial results last Thursday, followed by its compeer, Freddie Mac, on Friday. More than one year after the Federal Housing Finance Administration (FHFA) and the Treasury Department’s historic decision to bring these government-sponsored enterprises (GSEs) under the conservatorship of the FHFA, both institutions are struggling to return to profitability.
Fannie Mae reported a third-quarter net loss of $18.9 billion, relating principally to $22 billion in credit expenses, up from a loss of $14.8 billion in the second quarter. Freddie Mac reported a relatively smaller net loss of $5 billion, including $7.6 billion in credit-related expenses. The latter’s result was particularly disabusing, however, since Freddie Mac had reported a relatively modest profit of $768 million in the second quarter.
Under the terms of the senior preferred stock purchase agreement between the GSEs and the Treasury, the acting director of the FHFA made a request on Nov. 4 for funds necessary to offset Fannie Mae’s net-worth deficit. To avoid a mandatory receivership under the terms of the Federal Housing Finance Regulatory Reform Act of 2008, the public purse will now transfer $15 billion to Fannie Mae. This transfer will bring Fannie Mae’s net assets and obligations into balance for another quarter. Under the terms of the arrangement, the public commitment to Fannie Mae has risen to $60.9 billion over the past year. Freddie Mac, which maintained a positive net worth of $10.4 billion this quarter and which is not requesting additional Treasury funds for the time being, has received $51.7 billion to date.
The largesse of these financial commitments requires context: At roughly $50.4 billion, Canada’s entire federal budget deficit for 2009 ($54.2 billion in Canadian dollars) is smaller than the public transfers already made to either Fannie or Freddie.
The support has come at a high cost to both. Aside from their loss of independence, the dividend on the senior preferred stock is 10 percent. As a result, Fannie Mae now has an annualized dividend obligation of $6.1 billion payable to the Treasury; Freddie Mac, an annualized obligation of $5.2 billion. In its quarterly filing, Fannie Mae has indicated that its dividend commitment now exceeds its annual net income in five of the past seven years and that the expected growth in this obligation will make it increasingly difficult for Fannie Mae to return to profitability.
WHILE MANY OBSERVABLE MEASURES of housing market conditions are stabilizing, Real Estate Econometrics projects that home foreclosures in 2010 will exceed 2009 levels. As of the third quarter, the serious delinquency rate for Fannie Mae’s Single-Family Guaranty Book of Business had risen to 4.72 percent, up from 1.15 percent at the onset of the recession in the first quarter of 2008. The serious delinquency rate across Fannie Mae’s Multifamily Guaranty Book of Business is 0.62 percent. Across vintages, the serious delinquency rate is highest for loans originated in 2007. The loss curve suggests that Fannie’s 2008 multifamily mortgages will ultimately deteriorate further and faster than their 2007 counterparts.
Absent a new and unexpected policy intervention that will limit foreclosure activity (the extension of the home-buyer tax credit does not apply), Fannie and Freddie’s related losses will climb as the sum total of foreclosures rises. The government lifeline to the GSEs, which is authorized up to a total of $400 billion across both, must remain in place if the government wishes to continue its support for residential lending markets. While the mechanisms of housing finance are in need of a fundamental overhaul, the support system is warranted at this fragile juncture and in light of the important contribution of the GSEs to the housing recovery.
In its third-quarter filing, Fannie Mae has stated that “we expect to have a net worth deficit in future periods, and therefore will be required to obtain additional funding from Treasury pursuant to the senior preferred stock purchase agreement. As a result, we are dependent on the continued support of Treasury in order to continue operating our business. Our ability to access funds from Treasury under the senior preferred stock purchase agreement is critical to keeping us solvent …”
While reasonable people can disagree about the long-term need and raison d’être for Fannie Mae and Freddie Mac, the functioning of the residential mortgage market depends—at least for the time being—on their continued presence and active participation.
THERE IS NO DOUBT that Fannie Mae’s most recent quarterly loss comes at a difficult crossroads for the GSEs and for policy makers. As I described in my column of Sept. 15, the White House has indicated it will address the issue of Fannie Mae and Freddie Mac’s future structure with the next fiscal year’s budget proposal to Congress in February 2010. While Fannie and Freddie are serving vital policy roles in stabilizing single-family and multifamily housing markets—today’s sub–5-percent conforming mortgage rate would undoubtedly rise if the GSEs were suddenly shuttered—they are at an existential juncture.
Fannie Mae’s current filing speaks to this in highlighting that “there is significant uncertainty regarding the future of our business, including whether we will continue to exist, and we expect this uncertainty to continue.”
The possibility that being will give way to nothingness for Fannie Mae and Freddie Mac is problematic for the multifamily investment market. While unlikely, a negative shock to multifamily liquidity resulting from abrupt or heedless policy making will almost certainly undermine pricing and investment trends in the apartment market.
In that scenario, the large numbers of potential multifamily lenders who are now crowded out of the market by low-cost government funds will be able to re-enter but will not fill the shoes of the GSEs. The retrenchment of these lenders from other commercial real estate sectors will exacerbate the dearth of liquidity in the areas they now serve.
To avoid these potentialities, while also conceding that Fannie Mae and Freddie Mac must see their economic magnitude and significance diminished, a policy of gradualism—one that ultimately allows the private market to subsume those functions that can be met without government guarantees—is called for in shaping their new, more focused role.
Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.