Cheat Sheet: What Treasury's Move Means for GSE Reform

WASHINGTON — The Treasury Department's announcement Friday that it was restructuring its ongoing bailout of Fannie Mae and Freddie Mac caught most observers off guard.

While it was clear Treasury would have to do something before yearend — when a statutory cap limiting the amount of support the agency could extend to the government-sponsored enterprises would take effect — many had assumed it might wait until the deadline was closer.

The full impact of Treasury's move, meanwhile, was still being assessed as experts sharply disagreed over what it would mean for the stalled effort to reform the GSEs.

We offer the following frequently asked questions as a way to break down the issues.

So what happened?

Treasury announced early Friday that it would restructure the terms of its investments in Fannie and Freddie. It canceled a 10% annual dividend the companies must pay the government to recoup its line of credit with Treasury. Instead, Fannie and Freddie will now have to give Treasury all their profits. If there aren't any, they don't have to pay.

Treasury also announced it would speed up the reduction of the GSEs' mortgage portfolios by requiring a 15% annual reduction instead of 10%. That would mean the portfolios reach a $250 billion goal by 2018, four years ahead of schedule.

Why did Treasury do this?
Short of new legislation, it had little choice. In order to make their 10% dividend payments, the GSEs were forced to borrow more money from the government, a vicious cycle to which there was no end in sight. The trouble is, the amount of money they could borrow is about to get smaller.

The borrowing limits for Fannie and Freddie were set to fall by yearend to $125 billion and $150 billion, respectively. Those limits made the housing market nervous because, if unaddressed, hitting those caps could trigger a massive liquidity crisis that pales in comparison to the one caused by the fall of Lehman Brothers in 2008.

"It would make Lehman seem like a cherry in a 64-ounce Coke," said Karen Shaw Petrou, managing director for Federal Financial Analytics.

What do the mortgage portfolios have to do with this?
The reduction in mortgage portfolios is intended to provide political cover for the Obama administration, which is worried it will be accused of going easy on Fannie and Freddie. By pledging a quicker reduction in those portfolios, it can legitimately say it is speeding up plans to make the companies smaller.

The portfolio reductions help the Treasury "look tough," said Rob Zimmer, a former Freddie lobbyist who is now a principal for the consulting firm TVDC.

This also allows the administration to avoid talking about how — almost four years after Fannie and Freddie were put into conservatorship — it has not released a concrete plan for the future of the GSEs.

Does this help or hurt GSE reform efforts?
It depends on who you ask, but a number of observers see it as a setback for reform, while others contend it doesn't make much difference.

For some, Treasury's move is further proof the companies are nationalized, similar to the government-controlled Federal Housing Administration.

Each step in that direction makes it harder for Congress to reverse itself and later privatize the companies, as conservatives would like to do.

"Now Fannie and Freddie work for the U.S. government," said Paul Miller, an analyst at FBR Capital Markets. "You've nationalized the entities, it's not conservatorship anymore. It becomes a profit center for the government. Once something becomes a profit center, they don't let go of that. Look what they did for student loans."

Moreover, the threat of the December cut-off was seen as an incentive for Congress to take up legislation sooner rather than later, before the GSEs hit their cap on borrowing. With that looming obstacle out of the way, Treasury and Congress can put off dealing with the GSEs indefinitely.

Rep. Scott Garrett, the chairman of the House subcommittee that oversees the GSEs, said the cap should have provided impetus to find a different, permanent solution.

"It's not like December is coming up unexpectedly," Garrett, a New Jersey Republican, said in an interview. "We've thrown out a number of specific legislative proposals and we're still waiting for them to reply, which is typical of them."

Garrett said he was "taken aback" by Treasury's remarks Friday that it continues to work on bipartisan housing finance reform.

"That's clearly disingenuous," he said. "They've done nothing to work with Congress to wind them down."

But doesn't this help to wind down Fannie and Freddie?
Yes, and it makes it all but impossible for Fannie and Freddie to one day re-emerge from conservatorship similar to what they were before the crisis hit.

"Treasury is telegraphing in no uncertain terms that Fannie and Freddie have to get ready for their own demise," said Cliff Rossi, a former senior risk manager at Fannie and Freddie who is an executive-in-residence at the University of Maryland's Center for Financial Policy. "Everybody realizes that the likelihood of the GSEs remaining in their current form was slim to none."

David Min, a University of California-Irvine law processor, said Treasury is "foreclosing the possibility of Fannie and Freddie simply returning to their old model."

Indeed, some see Treasury's move as a way to eventually eliminate Fannie and Freddie altogether — albeit over a much slower timeframe than Republicans would like.

"This is a manner to gracefully wind the entities down that would be an end-run around requiring legislation," said Brian Harris, an analyst at Moody's Investor Services.

What happens next?
With or without Treasury's move, it's unclear who makes the next move, or when.

Despite what lawmakers say, the issue here isn't strictly Democrat vs. Republican. Treasury Secretary Tim Geithner has signaled he may be open to a dramatically smaller set of GSEs, and even potentially full privatization.

But the big players in the housing market — the National Association of Realtors, and National Association of Home Builders — oppose that idea. Those two groups, combined with lobbying power from the mortgage and banking associations, have enough influence to prevent Republicans from passing a privatization bill even if Mitt Romney is elected president and Democrats decamp to Mars.

Until there is some kind of agreement on how to proceed, GSE reform remains a tough nut to crack.

"There is not a consensus on the future structure of housing finance, and this decision reflects that," said Susan Wachter, real estate professor at the University of Pennsylvania's Wharton School of Business.