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GSEs could avoid bailouts with capital buffers

The Congressional Budget Office (CBO) has concluded that Fannie Mae and Freddie Mac could rebuild their capital buffers without significantly affecting the federal budget and that also would lessen the risk that the enterprises would need to take unpopular draws on the U.S. Treasury.

Such a move also would make the mortgage market marginally more stable and increase the availability of credit for consumers, but might also discourage private-label competition in the secondary market, the CBO said in report commissioned by the U.S. Senate banking committee.

GseThe CBO analyzed the impact of allowing each GSE to retain $5 billion annually in earnings up to a 10-year capped amount of $50 billion. Although the CBO offered up no recommendations, its findings could provide fuel for groups that have been urging the GSE’s regulator, the Federal Housing Finance Agency (FHFA), to allow the GSEs to rebuild their capital buffers.

“As its actions have demonstrated, the government is committed to ensuring that the mortgage market remains stable and that access to credit remains widely available,” the report said. “The policy option would probably make the market slightly more stable by reducing the likelihood of draws on the Treasury and the potential disruption that such draws could cause. CBO estimates that the probability that either Fannie Mae or Freddie Mac will draw additional funds from the Treasury in the next 10 years would fall significantly under the option.”

The report further concluded that the impact on the federal budget would be small, largely because the government has already pledged to backstop Fannie and Freddie in the event they suffer losses.

The GSEs were bailed out and taken over by the government in 2008. Fannie and Freddie’s earnings are entirely swept up by the Treasury, and their capital reserves are scheduled to be wound down to zero by 2018. In return for the profit sweeps, the government has agreed to cover any quarterly losses that the GSEs can’t cover. These are known as draws, but technically the Treasury purchases additional preferred stock in the companies.

In recent years, both the GSEs generally have been profitable. As of September, Fannie and Freddie have returned roughly $250 billion to the Treasury, about $63 billion more than they originally drew in the 2008-to-2012 period, CBO said. The government has made available an additional $258 billion to cover any future losses.

Draws, which are often characterized as “taxpayer-funded bailouts," are politically unpopular, however. Numerous groups on the left and right, including a few mortgage trade groups, have urged Treasury and the Federal Housing Finance Agency to allow the GSEs to retain earnings. FHFA's Director Mel Watt has predicted that the GSEs will inevitably have to take draws once the capital buffers are wound down because the quarterly earnings tend to be volatile.

The Congressional Budget Office report said it was unlikely that Fannie and Freddie would ever exhaust the amount that they could potentially draw from the Treasury. The extra capital cushion would, however, reassure investors in the GSE-issued mortgage-backed securities.

The CBO said that if Fannie and Freddie made large draws on the Treasury, it could erode confidence in the GSE securities, and investors might pull back, making it harder for lenders to fund home loans. The GSEs purchase about half of all home loans and package most of those into securities, which are guaranteed by the government's backstop. On the other hand, reducing the government's enormous footprint on the mortgage industry has been one of the goals of GSE reform. The CBO also noted that if Fannie and Freddie are allowed to rebuild their reserves, it might signal to the market that the GSEs are here to stay, and private-label securities companies wouldn’t try to compete against them. 

The CBO didn’t make any recommendations in its report, but it could provide fuel for groups that have been urging the FHFA to use its power to suspend the profit sweeps. Glen Corso, executive director of the Community Mortgage Lenders of America (CMLA), said he was encouraged by the report's findings.

“The CBO report supports the position of CMLA and the Main Street GSE Reform Coalition that FHFA should permit the GSEs to build a capital buffer to reduce the possibility that quarterly fluctuations in GSE income will require an additional draw on the Treasury lines of credit,” Corso told Scotsman Guide News. “We trust FHFA will act promptly.”


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