Photographer: Craig Warga/Bloomberg

Fannie-Freddie Watchdog Says He Can't Let Capital Go to Zero

  • FHFA Director Watt says investor confidence would be eroded
  • Watt also rebuffed ‘recap and release’ during Senate testimony

The head of Fannie Mae’s and Freddie Mac’s regulator told lawmakers Thursday that he can’t take the risk of letting the companies run out of capital.

Investors in Fannie’s and Freddie’s mortgage bonds might begin to doubt the safety of their holdings if the companies need more bailout money, Federal Housing Finance Agency Director Mel Watt said at a Senate Banking Committee hearing. Such a scenario could disrupt the housing market and cause rates to rise, he said.

Spiraling losses triggered a taxpayer rescue of Fannie and Freddie during the 2008 financial crisis, and prompted them to be put under government control. The bailout terms require the mortgage giants to make quarterly dividend payments to Treasury and face declining capital buffers slated to fall to zero next year. Unless the arrangement is changed, the companies would have to seek new aid to cover any quarterly loss.

The FHFA “cannot risk the loss of investor confidence” that would result from Fannie and Freddie running out of capital, Watt told senators. In response to questions, he declined to specify how much of a buffer was sufficient but said he had discussed the issue with the Treasury Department.

$266 Billion

Watt also emphasized that Congress, not the FHFA, should determine the future of Fannie and Freddie. He said that if he did change the dividends, it shouldn’t be interpreted as a step toward recapitalizing the companies with the aim of freeing them from government control.

The companies, since returning to profitability, have paid about $266 billion to the Treasury. Any changes would be highly controversial, and would put Watt in direct opposition to President Donald Trump’s administration, which has said the payments should continue.

Some Republican senators said building capital was unnecessary.

In an exchange with Tennessee Senator Bob Corker, Watt made the case that the potential consequences of the need for more bailout funds were so dire that it was his responsibility to prevent it. Corker said that Watt’s concerns were “one of the most baseless arguments that I’ve ever heard,” citing the more than $250 billion that the U.S. Treasury has committed to backstop the companies in case of a downturn.

“I can’t afford to assume that risk,” Watt said.

Some Democrats were not opposed to Watt’s desire to let Fannie and Freddie retain more capital. “There is no reason we cannot protect taxpayers and homeowners. Protecting taxpayers in the near term should be a shared bipartisan goal,” said Senator Sherrod Brown of Ohio, the Banking Committee’s top Democrat.

Private Investors

Some Fannie and Freddie shareholders also want them to retain capital, viewing it as a step toward releasing the companies and allowing profit to flow to private investors. In addition to individual investors, holders of Fannie’s and Freddie’s preferred and common stock include funds managed by Fairholme Funds, Paulson & Co., Perry Capital and Pershing Square Capital Management.

Investors in the companies’ shares cheered the news. Some classes of Fannie Mae preferred shares were up more than 10 percent as off late morning. Shares of Fannie common stock rose 5 cents, or 1.9 percent, to $2.73 and Freddie’s stock rose by about 4 cents to $2.62.

“Congress urgently needs to act on housing finance reform,” Watt said in his testimony. “I want to reaffirm my strong belief that it is the role of Congress, not FHFA, to make these tough decisions that chart the path” out of government control,” he said.

In return for the $187.5 billion that they government injected into the companies in 2008, the Treasury received a new class of preferred shares that originally paid a 10 percent dividend, along with warrants to acquire nearly 80 percent of their common stock.

Changed Terms

In 2012, the government changed the bailout terms. Instead of a 10 percent dividend, every quarter the companies would send the government all of their net worth above a capital buffer, which started in 2013 at $3 billion. The buffer was designated to decline by $600 million each year, until reaching zero in 2018.

Watt, who noted that the declining buffer was intended to spur housing-finance reform, has raised concerns about the declining capital for more than a year. He has cited the possibility that one or both of the companies could again need to draw on taxpayer funds.

The companies still have a combined $259 billion in available funding to cushion against losses, but Watt has said that mortgage-bond investors could begin to doubt the strength of the companies’ bond guarantees before that money gets exhausted.

The FHFA chief came close to allowing the companies to rebuild capital at the end of March, a person familiar with the matter has said, but the companies paid their dividends to the Treasury as scheduled.

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