In a move that virtually ends any hope that Freddie Mac and Fannie Mae will return to viability, the Department of the Treasury and the Federal Housing Finance Agency (FHFA) have revised the Preferred Stock Purchase Agreement (PSPA) between Treasury and the two government sponsored enterprises (GSEs).   The new agreement will strip the GSEs of any profit from their operations and will accelerate the rate at which they are reducing their owned loan portfolios.

The agreements will replace the 10 percent dividend payments made to Treasury on its preferred stock investments in Fannie Mae and Freddie Mac with a quarterly sweep of every dollar of profit that each firm earns going forward.  Under the existing agreement the Treasury Department has provided financial support to the GSEs in the combined amount of $188 billion since conservatorship began in August 2008.  The GSEs have paid Treasury $46 billion in dividends during this period frequently needing to request additional funds from Treasury in order to do so.

In addition the investment portfolios held by the two companies will now be wound down at an annual rate of 15 percent instead of the 10 percent annual reduction required in the previous agreements. As a result of this change, the GSEs' investment portfolios must be reduced to the $250 billion target set in the previous agreements in 2018, four years earlier than previously scheduled.

The changes will prevent the companies from rebuilding capital, and dashes the hopes of investors who bought GSE stock on the cheap hoping they might re-emerge from conservatorship as viable companies.  It also appears that the demands of many members of Congress to terminate the GSEs as rapidly as possible are being met.   

"With today's announcement, we are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac, while continuing to support the necessary process of repair and recovery in the housing market," said Michael Stegman, Counselor to the Secretary of the Treasury for Housing Finance Policy.  "As we continue to work toward bi-partisan housing finance reform, we are committed to putting in place measures right now that support continued access to mortgage credit for American families, promote a responsible transition, and protect taxpayer interests."

A press release from Treasury said that the "sweep" of GSE profits into the Treasury coffers would accomplish several things: 

  • Ensure that every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms.
  • End the circular practice of the Treasury advancing funds to the GSEs simply to pay dividends back to Treasury.
  • Support the continued flow of mortgage credit by providing market players and taxpayers with additional confidence in the ability of the GSEs to meet their commitments and provide greater market certainty regarding the financial strength of the GSEs.

Treasury said the move was also in line with the Administration's 2011 White Paper commitment to wind down the GSEs while not allowing them to retain profits, rebuild capital, and return to the market in their prior form.

Both GSEs have recently reported substantial profits.  Fannie Mae, in its second quarter financial report claimed $7.8 billion in net income in thus far in fiscal 2012 compared to a loss of $9.4 billion at the same point in 2011 and Freddie Mac reported second quarter net income of $3.0 billion compared to $577 million one year earlier.  Both companies paid the required dividends for the second quarter and neither requested additional funds. 

Apparently the markets were still fearful that the companies might exhaust their Treasury support, especially as a temporary agreement to provide unlimited money ends this year and the Treasury obligation returns to its original level which will allow it to inject an additional $125 billion into Fannie Mae and $150 billion into Freddie Mac.

A press release from FHFA contained the following statement.  "As Fannie Mae and Freddie Mac shrink, the continued payment of a fixed dividend could have called into question the adequacy of the financial commitment contained in the PSPAs.  In addition, the faster reduction in the retained mortgage portfolio will further reduce risk exposure and simplify the operations of Fannie Mae and Freddie Mac.

"These changes provide certainty to Fannie Mae, Freddie Mac and market participants as they continue to perform their critical mission of providing liquidity and stability to the country's housing market.  The steps today are also important as Congress and policymakers contemplate the future of Fannie Mae and Freddie Mac."