Like the mast of a sailing ship coming over the horizon, the first sign that Congress may restructure Fannie Mae and Freddie Mac has appeared.
The common wisdom in Washington is that nothing of significance will happen on GSE reform during the year remaining in this Congress. House Republicans may pass one of their pending bills, all of which would eliminate Fannie and Freddie but some say do not adequately address needed transitions or possible GSE successors. Their free market faith that people will put up with higher mortgage costs and long periods when mortgage money may not be available at all is admirable. It is not, however, shared by many of their colleagues in the Senate in either party. There is no sign the Democrat-controlled Senate will be anything except a graveyard for any Republican House version of GSE reform.
Senate Republicans, who believe they will be in the majority after the next election, and perhaps have a Republican House and president as well, are not inclined to compromise with their Democrat colleagues to get a bill done. Why give the Obama administration an accomplishment to trumpet in its campaign? The bottom line, according to the Common Wisdom: gridlock and no action on GSE reform in any form. Accordingly, on February 21, 2012, FHFA Acting Director Ed DeMarco announced plans for the continued opertion of the conservatorship in light of inaction by Congress.
Events, however, may force Congress to move whether it wants to or not, this year or early next year.
The driver is the expiration of the 2009 "Christmas surprise," in which Treasury Secretary Timothy Geithner made unlimited funds available to ensure that Fannie and Freddie remained solvent and, by strong implication if not law, that their bonds were covered by the full faith and credit of the United States.
The Sept. 26, 2008 preferred stock purchase agreements between the Treasury and Fannie and Freddie were made under authority granted in the Housing and Economic Recovery Act to buy agency securities until Dec. 31, 2009. The agreements were written so that Treasury was paid up front (warrants plus $1 billion in preferred stock) to provide a total of $100 billion of support for each GSE. The amount of the support is set and the cash is disbursed as needed on a quarterly basis. In May 2009 an amendment to the agreements doubled the amount to $200 billion each.
On Dec. 24, 2009, seven days before the expiration of his statutory authority, Geithner announced a second amendment, essentially providing unlimited support for each GSE, i.e. $200 billion plus any deficiencies.
The "unlimited" support comes to an end in December of this year. After that the matter rolls back to the older agreement of total support of $200 billion. A month after the next election, then, the losses that will be realized by the GSEs from operations and from liquidation of the dreadful mortgages in their legacy retained portfolios will either approach or exceed the limit of government support.
There is no relief in sight from more losses. Exceeding $200 billion is a matter of when, not if, for the GSEs.
It is true that the GSEs may create reserves for future losses until the end of 2012. Since these reserves flow through earnings and are booked as losses under generally accepted accounting principles, they are also eligible until the end of the year for unlimited reimbursement. After 2012 then, the amount of money available to cover future losses will be the reserves created and the balance of preferred stock authorized up to $200 billion. That's it.
Secretary Geithner has no way to go back and increase the May 2009 upsizing of support. The statutory deadline has now passed. New legislation will be needed to raise the limits.
Having announced his expectation of being replaced as Treasury Secretary, Geithner will either address the problem before he leaves or dump it in the lap of his successor, regardless of which party elects a president. His recent remarks that administration will actually soon have a legislative proposal for GSE reform soon indicate an intention to take the first and more honorable route.
The inclination of Congress is to take a pass on the issue of GSE reform until after the election. The problem is that the Treasury support expires in December, while the new Congress is formed in mid-January and starts working in February. The need to avoid market disruptions in GSE debt and mortgage-backed securities could force Congress to move much farther then they originally intended in considering GSE reform.
At a minimum, enacting a short term extension at the end of the year to buy more time may be necessary. The problems with short term extensions are well known – think payroll tax cuts — so the impetus to actually complete GSE reform legislation this year, and not kick another can down the road, is much stronger than expected.
At this point we are not sure Congress is even aware of the problem that is coming after the election. The sooner they act, the better. Let's hope their eyes are focused on the horizon.
Stephen A. Blumenthal is a partner at Williams and Jensen PLLC, and the former deputy director and acting Director of the Office of Federal Housing Enterprise Oversight, a predecessor of the Federal Housing Finance Agency.