Fannie Mae's and Freddie Mac's recent financial results have significantly exceeded even the government's most optimistic projections, making the fees they charge lenders suddenly relevant to determining their future.

As recently as October, the Federal Housing Finance Agency estimated the government-sponsored enterprises' ongoing government bailout would exceed $202 billion by mid-2012 in the best-case scenario. At worst, the hole would total around $250 billion. And under all circumstances, they would still be getting deeper in debt.

The last three quarters have been far kinder to the GSEs than that. Because of the stabilization in house prices, neither Fannie nor Freddie has had to borrow significant money from the Treasury since the beginning of the year, leaving the total tab for their bailout at around $190 billion.

Now that they've stabilized, what fees their conservator charges could well determine their fate.

The housing giants earn such guarantee fees from lenders in exchange for assuming the credit risk on conforming loans, with the ultimate cost being passed through to borrowers. The FHFA, as the GSEs' conservator, determines the rates.

Should the FHFA raise fees only slightly, that would keep mortgage rates down and make the GSEs permanent wards. Raising them high enough could eventually resurrect a private securitization market and shrink Fannie and Freddie. Should the regulator take a middle route of moderate increases, it could turn the GSEs into a serious income generator — assuming there's not another crash.

"The fee mechanism is the easiest lever to throw regarding GSE reform," says Tim Rood of the Collingwood Group, a consulting firm focusing on federal housing finance. "The FHFA has proved to be the only political or regulatory body that's willing to act."

The primary reason why Fannie and Freddie have stabilized is that the housing market has improved, which halted losses and allowed the two GSEs to release more than $2.6 billion in reserves over the last two quarters. But the cessation of bleeding is a reminder of something else: the extremely simple business of selling government guarantees on loans is highly lucrative, at least on a short-term basis.

"It's a powerful thing, how much the government guarantee is worth," says Dave Stephens, the chief operating officer and chief financial officer at UCM, a Denver firm that hedges mortgage servicing.

To be sure, income from fees won't be able to pay down the GSEs' debts if fees remain at or near their current rates. Even during the current refinance boom, gross fee revenue is on track to pay off for only $12 billion of the $19 billion in interest owed to the government this year. Guarantee income still lags behind interest income from the GSEs' portfolios of loans and securities.

"Even if all future legacy…losses have been reserved for and the post-conservatorship vintages realize zero credit losses, the guarantee business does not generate enough income relative to senior preferred dividends that must be paid to the Treasury," wrote Barclays analyst James Ma of the Fannie and Freddie results.

FHFA Director Ed DeMarco has been similarly blunt about the GSEs' prospects of paying down their debts.

"It ought to be clear to everyone at this point, given [Freddie Mac and Fannie Mae's] losses since being placed into conservatorship and the terms of the Treasury's financial support agreements, that [Freddie Mac and Fannie Mae] will not be able to earn their way back to a condition that allows them to emerge from conservatorship," he said last September.

This could readily change, however, with an adjustment of the GSEs' fee schedule. When Congress approved a 10 basis-point fee hike in April to cover the cost of a payroll tax cut extension, the Congressional Budget Office estimated that it would generate an additional $3 billion to $4 billion a year. The FHFA is expected to announce another hike shortly, with Fannie and Freddie keeping the proceeds. And this will come on top the higher "delivery fees" Freddie Mac is already charging; in the second quarter its total average fees on single family loans rose to 24 basis points, up from less than 19 a year earlier.

These hikes lend themselves to simple math, with fee revenues on new production rising in line with the increases. In the second quarter Fannie earned $2 billion, an effective average of 27 basis points, in fees on its current single-family portfolio. New production produced an average of 40 basis points in fees, however.

"The FHFA is in a position of tremendous power," says Rob Zimmer, a principal of consulting firm TVDC and a lobbyist for Community Mortgage Lenders of America. "The GSEs will repay the taxpayers unless Washington goes out of its way to ensure they don't."

Exercising its power could be politically dicey for the FHFA, Rood notes.

"If the fees go up incrementally to a point that is so distasteful to policy makers and raises the cost of housing, then there could be a political backlash," he says.

The FHFA, which did not respond to a request for comment before press time, has so far telegraphed its intent to raise fees gradually. Fee increases aren't intended to make money, it has said, so much as to eventually reduce Fannie's and Freddie's central position in the market. In the agency's June annual report to Congress, the GSEs' regulator described intentionally diminishing their advantages as "the next chapter" of conservatorship, setting the stage for Congress to redefine their role or eliminate them.

"The final chapter… remains the province of lawmakers," the FHFA report says.

Whether lawmakers visit that province even after the election is an open question. Collingwood's Rood argues that the future of the GSEs "will be taken more earnestly" once November passes. Others remain skeptical that the next Congress will be more eager to address the subject.

"There's no upside for Republicans in taking a vote on anything other than liquidation, and that vote's never going to come," says Zimmer. "No Republican's going to be thanked for building a better hybrid mousetrap."

That would leave the FHFA responsible for guessing how high it would have to raise prices to restart the private market, Zimmer argues.

UCM's Stephens estimates that investors would buy vanilla housing securities without a government guarantee for a premium of about 50-75 basis points above where fees have traditionally been set, though such a spread is obviously hypothetical.

Others say the question of where the private market would price conforming loan securities is still premature. Because discussions on how to revive securitization and the definition of "qualified residential mortgage" are still underway, it's impossible for private sector securitizers to know the terms on which they could enter the market. Until then, Rood says, fee hikes amount to "showing a little leg to the private market."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.