Washington may have discovered a new way to shrink the $17 trillion national debt. But you won't hear anybody crowing about it.
Fannie Mae (FNMA) and Freddie Mac (FMCC) — the once-doomed federal housing agencies — have both reported record profits for 2013: $84 billion for Fannie and $45 billion for Freddie, or a total combined profit of $129 billion. Apple (AAPL), by comparison, earned a puny $37 billion in 2013. Exxon Mobil earned (XOM) $33 billion; Walmart (WMT), just $16 billion. In 2008, Exxon edged out Freddie’s $45 billion profit by a couple hundred million dollars, but Fannie’s $84 billion trophy last year appears to be the largest annual profit ever recorded by a company.
Here’s the kicker: Instead of going to shareholders, Fannie and Freddie’s profit goes to the U.S. Treasury, because of the government takeover of both agencies during the 2008 financial crisis, when they became insolvent and would have declared bankruptcy without federal intervention. The mortgage bailout cost a total of $187 billion, the single largest taxpayer expense in a blizzard of bailouts. At the time, virtually nobody thought the agencies would be able to repay that money. But they finally have – and now their profits are helping run the government and pay down the national debt.
Fannie and Freddie: "People hate them"
This isn't exactly the way the government is supposed to be financed. "I don't think it's desirable," says Douglas Holtz-Eakin, president of the nonprofit American Action Forum and former director of the Congressional Budget Office. "Fannie and Freddie have better name recognition than most politicians – and people hate them."
That wasn't always the case, however. For most of their history, the two Congressionally chartered agencies were the benign, unseen hand of the housing market. They don't grant loans, but rather buy qualified mortgages once lenders have issued them, and roll them into securities that trade on public markets. That keeps cash flowing to banks and encourages them to lend more. Had Fannie and Freddie disappeared in 2008, it could have seized up the entire housing market, turning a recession into a depression.
Though the agencies have always had an undefined quasi-governmental role, they also issued public shares, which still trade over-the-counter. Before the housing bust, some private companies did the same thing as Fannie and Freddie. But they’ve gotten out of the business, leaving Fannie and Freddie with a near-monopoly in their industry. A few prominent investors have been snapping up Fannie and Freddie shares recently, figuring the government will relinquish its ownership and convert the two firms to normal public companies at some point, which could push the stock up 10- or 20-fold. There are also a number of lawsuits that could produce the same outcome, brought by prior shareholders arguing that the 2008 takeover — which pushed the shares close to 0 — was unlawful.
A surprising asset
In the meanwhile, the two agencies have become a surprisingly valuable government asset, raising the intriguing question of whether Washington should continue to operate them as a profit center. Republicans and Democrats have different ideas about how the government should unwind its investment in the two companies, but in general they agree that Washington shouldn’t be in the business of running for-profit operations that interfere with the normal functioning of markets.
Yet calls for the reform of Fannie and Freddie have quieted now that they have become a kind of government bank turning out far bigger profits than Goldman Sachs (GS) or J.P. Morgan Chase (JPM). There are a couple of bills in Congress that would gradually wind down the two agencies, while transferring their functions to a variety of other agencies or the private sector. But there's little consensus on the matter and little urgency to do anything in an election year.
There’s one other big profit center in the government: the Federal Reserve, which by law must turn over its profits to the Treasury. In 2013, the Fed sent $78 billion to the Treasury, after an $88 billion payment in 2012. Most of that income comes from interest paid on the huge portfolio of bonds the Fed has purchased under its controversial quantitative easing program, which it plans to wind down. So Fed profits should fall sharply in coming years.
Profits for Fannie and Freddie will most likely fall as well, since the runup in home prices in 2013 — which boosted their returns — will almost surely decelerate. Still, the Fed and the two mortgage agencies combined could easily contribute $50 billion to $100 billion per year to government coffers over the next several years. Even in Washington, that’s a tidy sum. The 2-percentage-point increase in the payroll tax last year, by comparison, will raise about $120 billion per year. A $100 billion annual contribution to government revenue could cut the annual deficit by nearly 20%.
It’s important to keep in mind that Fannie and Freddie, and even the Fed, can also lose money, which would come out of taxpayer pockets. If that ever happens, lawmakers would howl loudly once again and quickly propose a fix. Absent such a crisis, however, the status quo looks increasingly tolerable.
Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.
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