Stress Tests Reveal Potential for $190B GSE Bailout
Secondary mortgage market giants Fannie Mae and Freddie Mac could either repay money owed to the U.S. Treasury or wind up needing billions more from U.S. taxpayers. That conclusion was reached by the Federal Housing Finance Agency in an April 30 report on GSE stress testing.
The Dodd-Frank Act mandated the FHFA, which serves as the GSE’s conservator and regulator, conduct stress tests on Fannie Mae and Freddie Mac that resemble those the Federal Reserve performed on the largest banks.
The FHFA also released the results of its customary financial performance projections that it conducted in conjunction with this first year of the stress tests. Next year, it will only be required to conduct the stress tests, the agency said.
“The projections reported here are not expected outcomes,” the agency wrote in its report. “They are modeled projections in response to 'what if' exercises based on assumptions about enterprise operations, loan performance, macroeconomic and financial market conditions, and house prices. The projections do not define the full range of possible outcomes. Actual outcomes may be very different.”
Projected possible financial losses that would require government assistance range from $84.4 billion to $190 billion. Under three possible FHFA scenarios, the GSEs do not take any additional public money at all, but instead pay dividends to the Treasury between $36 billion and $54 billion.
The GSEs have already made dividend payments to the Treasury worth more than $200 million, according to the agency's website.
Dodd Frank mandated testing models included a decline of 25% in U.S. home prices spread across a little more than two years, while simultaneously during a shorter time frame, prices for mortgage backed securities dropped between 20% and 90%. Additionally, that scenario also included instantaneous default of the largest counterparty for securities financing transactions and derivatives.
By contrast, the FHFA scenarios envision, at most, a loss of between 2% and 4% in home prices over two years, with a potential increase in prices of between 12% and 13%.
While it did not comment on the Dodd Frank mandated assumptions in its report, the FHFA pointed out that it has been making projections since 2010, and that actual market conditions and financial results have come close to those projections.
“[P]rojected financial results have improved each year driven by these key factors,” the FHFA wrote. “First, the enterprises’ single-family portfolio quality has improved over time, reducing the exposure to single-family credit. The FHFA also noted its single family credit guarantee portfolios now have substantially fewer delinquent loans, and less exposure to losses than they were projected to have in 2010.
A spokesman for the agency also pointed out that the GSEs appeared to perform poorly under the catastrophic scenario in part because they are not allowed to retain any of their earnings, which might serve as a buffer against such losses.
Instead, the terms of the government takeover in 2008 dictate that earnings are forwarded to the U.S. Treasury.
The release of the stress test report comes at a time when it appears progress toward legislation on reforming the secondary mortgage market has stalled.
The Senate Banking, Housing and Urban Affairs Committee was supposed to mark up a measure backed by Sen. Mike Crapo (R-Idaho) and Sen. Tim Johnson (D-S.D.) on April 29 and pass it on to the Senate floor for a potential full vote. However, the committee refrained while backers sought to build stronger support.
“I am confident that if we held the vote this morning, we would have more than the minimum number of votes needed to pass it on to the floor,” said Crapo, the ranking minority member on the committee.
“Nevertheless, while I do not relish the idea of a short delay, I am pleased that a number of senators believe with just a brief period of additional time to consider it, they will have the opportunity to productively join us in efforts to reform the current system. I look forward to working with my colleagues in the coming days, to listening to their questions or concerns to help us find a bipartisan consensus with even stronger votes,” Crapo also said.
But analysts have pointed out that while backers take additional time to build support, critics can also use that time to build opposition, such as Ken Blackwell, director of the Coalition for Mortgage Security, a bipartisan GSE reform organization.
“Today’s brief Senate Banking Committee markup session on the Johnson-Crapo bill is an indication of the growing opposition – across the political spectrum – to bad legislation,” Blackwell said on April 29. “This bill will not reform Fannie Mae and Freddie Mac intelligently, it does not protect property rights and it actually keeps in place the mechanisms that could lead to another financial collapse.”