Will Improvement at GSEs Sap Urgency of Debate?

The conversation about what to do with Fannie Mae and Freddie Mac may soon get a little more interesting.

The latest quarterly results from the government-sponsored enterprises suggest that after two and a half years and $230 billion of losses, there is a light at the end of the tunnel. Some analysts say one or both GSEs could conceivably turn a profit, or at least break even, in the next couple of quarters.

Their improving financial picture, some say, could influence the debate over their future makeup, with drastic and immediate reform seeming less imperative.

"The trend line, if you want to follow it out, may indicate that we can be more patient and thoughtful about the reforms that are introduced and there doesn't need to be any massive intervention that has to occur with lightning speed," said Mark Nuccio, co-head of the banking practice at the law firm Ropes & Gray.

Make no mistake: Fannie and Freddie are still hemorrhaging money. Combined, the two firms lost $9 billion in the second quarter.

But the bleeding has slowed and the credit quality of the newest loans in their portfolios is pristine.

Some who favor major changes to the GSEs' structure say they fear such trends could encourage half measures.

"I don't think the inevitable improvement in their financial performance will create sufficient momentum behind an argument that somehow the status quo is acceptable," said Raj Date, the chairman and executive director of the Cambridge Winter Center for Financial Institutions Policy, who advocates full nationalization. "However, I do think that it will inappropriately give weight to relatively incremental changes to the market as opposed to substantial changes to the market."

On Monday, Freddie posted a net loss of $6.01 billion, after a $1.3 billion preferred dividend payment to the government. That compared with net losses of $840 million in the second quarter of 2009 and $7.98 billion in the first quarter of this year.

"I think you'd be hard pressed to look at Freddie's results and see good news or see that much," said Brian Harris, a senior vice president at Moody's Investors Services. "You're still talking about a large loss."

Nevertheless, the amount of money Freddie set aside to cover future losses dipped 11% from the second quarter of last year, to $5.03 billion. Net chargeoffs and nonperforming assets rose.

The delinquency rate on single-family mortgages in its portfolio declined to 3.96% from 4.13% at the end of the first quarter, though that was higher than the 2.89% delinquency rate a year earlier.

The biggest impact to Freddie's bottom line came from derivatives-related losses of $3.8 billion.

Excluding the derivatives losses and including an increase in the value of written-down securities, Freddie's total comprehensive loss was $430 million. Because of that loss and its dividend payment to the government, Freddie said it would submit a request to the Treasury Department for $1.8 billion to plug its net worth deficit.

Fannie also said it would seek additional funding from the government when it reported a $3.1 billion loss for the second quarter on Friday.

That was a big improvement, though, over the $15 billion loss it recorded in the second quarter of last year, as its credit expenses dropped 74%.

Fannie asked the government for another $1.5 billion, but said it expects further draws from the Treasury will be driven by its dividend payments to the government, not credit losses.

Those dividend payments will hurt both Fannie and Freddie over time, no matter how much income they generate, Harris said.

"They can generate some solid net income potentially but they owe billions of dollars of preferred stock dividends," to the government, he said. "That is going to reduce the net income."

Still, some experts said the latest numbers are ambiguous enough that Republicans or Democrats could use them to their advantage.

"Someone could paint this as horribly bad news, or less-bad news," Nuccio said.

Others say the financial performance of Fannie and Freddie won't matter as much as policymakers' world views.

"There's a philosophical divide about what the appropriate role of the federal government in the housing market should be," said Howard Glaser, who runs the Glaser Group, a Washington legislative and regulatory consulting firm. "Periodic variations in Fannie and Freddie performance doesn't affect these deeply held beliefs about what the federal role should be. It's going to be a very sharply focused and intense debate and whether Fannie and Freddie are up or down on any given day is more background noise than anything else."

Republicans have generally been in favor of privatizing the GSEs and reducing their reliance on government support. Democrats, meanwhile, believe some sort of government guarantee is necessary to keep the housing market afloat.

Josh Rosner, managing director of Graham Fisher & Co., said the debate will only grow louder as midterm elections approach.

"We're in a world of midterm elections and a world in which the administration is obviously in trouble on the midterm election front," he said. "Who knows what Fannie and Freddie will be used to do or not to do."

Worried about disrupting the fragile recovery of the housing market, the Obama administration has held off on reforming the GSEs, to the dismay of Republicans, who have insisted that it's imperative to address the agencies that played such a big role in the collapse of the housing market.

Though the Dodd-Frank legislation did not touch on what to do with Fannie and Freddie, it specified that the Treasury should submit to Congress a comprehensive plan for reform no later than the end of January.

Next Tuesday, the White House will host a conference on the future of the GSEs at the Treasury Department, which should offer a glimpse into the coming battle over their reform.

Academic experts, consumer and community organizations, industry groups and other housing market players are expected to participate.

Jeff Taft, a partner at law firm Mayer Brown in Washington, said that the second-quarter numbers could be spun in a positive way.

But that doesn't necessarily make reform any less imperative, he said.

"I personally feel and others would probably agree that quarterly changes or upticks in the housing market don't necessarily mean that the housing market is on its way to good health in the United States," Taft said.

"They may swing back to profitability but the bottom line is they are still government owned at this point. No matter how profitable they are, they still need to be reformed."

If reform is delayed in any way, though, it may become harder to make significant changes.

"The longer it takes to enact reform, the harder it's going to be to change these institutions," Harris said.