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Moody's: GSE privatization won't happen soon

Don’t count on a quick end to the government’s control of Fannie Mae and Freddie Mac, Moody’s Investors Service says.

Despite U.S. Treasury Secretary-designate Steven Mnuchin’s comments last week on Fox Business News that the Trump Administration will make a quick end to the conservatorship of the two government-sponsored enterprises (GSEs), political and financial realities stand in the way, according to Moody’s.

GsE“Despite Mr. Mnuchin’s comments, we believe that there is a very low probability that the GSEs will be privatized over the next few years given their capital needs and complexities of privatization,” a Moody’s report states.

One major obstacle involves the GSEs diminishing capital buffers, which have been wound down to $1.2 billion each and are scheduled to go to zero by 2018. The GSEs were bailed out and placed into conservatorship in 2008, but all their profits are swept up by the U.S. Treasury. If the GSEs suffer losses and their net worth dips into negative territory in any given quarter, they can take a Treasury draw.

The government has made billions of dollars available to the GSEs in the event of losses. This, in turn, gives GSE securities an explicit guarantee by the federal government. Removing that guarantee could dry up investor interest in the securities, and cut off the funding to lenders making new loans. It also could cause the costs of mortgages to skyrocket. Fannie and Freddie indirectly finance roughly half of all home loans in the country by purchasing mortgages from lenders and securitizing them.

“In order for privatization to work, and assuming the GSEs would continue to participate in the mortgage market as they do today, they would need a strong capital base that likely totals in the hundreds of billions of dollars,” the Moody’s report states. “And, confidence in their financial standing would be critical given the need to refinance their debts during any transition to becoming a private company.”

Politics also are potentially in play, Moody's noted. The U.S. Treasury and the Federal Housing Finance Agency have the power to end the profit sweeps, to begin rebuilding the GSEs capital and to end the conservatorship. FHFA Director Mel Watt, an appointee of President Barack Obama, has two years left to serve out a five-year term.

“Based on Mr. Mnuchin’s comments, the US Treasury is (or soon will be) ready to end conservatorship,” Moody’s states. “However, the FHFA’s views are less clear, and we believe that FHFA Director [Watt] would resist taking these actions. Mr. Watt has given no indication that he believes the GSEs are healthy enough to end conservatorship.”

Moody’s also noted that privatization would be “credit negative” for the GSE securities because of all the questions it raises. Moody’s said its AAA rating of GSE securities assumes a government backing. Moody’s said it believes the future reforms to the GSEs will preserve the backing on loans originated before any reforms.

“Nevertheless, there are alternative reform outcomes that would be less creditor friendly, as well as many variables that could change the path of reform, making the ultimate outcome highly uncertain,” the Moody’s report states. “Although we recognize this overall uncertainty, we also believe that any change in the GSEs’ current setup is unlikely to occur during our rating outlook horizon of the next 12 to 18 months, and thus we have a stable rating outlook.” 


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