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Fannie-Freddie Watchdog Demands Capital Above $280 Billion

Joe Light
·5 min read

(Bloomberg) -- Fannie Mae and Freddie Mac will be required by their regulator to hold hundreds of billions of dollars in capital to protect against losses, a step considered crucial to freeing the mortgage giants from U.S. control.

The Federal Housing Finance Agency rule finalized Wednesday stipulates how much of a capital cushion the companies would have to maintain against their assets as fully private entities in order to weather a financial crisis. The combined total could exceed $280 billion, and Fannie and Freddie would likely need to sell shares and retain earnings for years to raise the funds.

Finishing the capital rule has been a top priority for FHFA Director Mark Calabria, who during his tenure has aggressively pushed a Trump administration goal of ending Fannie and Freddie’s 12-year-old government conservatorships. Yet any plans for releasing the companies could be upended by Joe Biden’s presidential election win, as his incoming administration is expected to have a much different take on housing-finance policy.

“FHFA is confident that the final rule puts Fannie Mae and Freddie Mac on a path toward a sound capital footing,” Calabria said in a statement. He called the regulation “another milestone necessary for responsibly ending the conservatorships.”

Fannie and Freddie don’t make mortgages. They buy them from lenders, wrap them into securities and guarantee repayment of principal and interest to investors. The federal government took control of the companies during the 2008 financial crisis and bailed them out with around $187.5 billion as mortgage defaults mounted.

Mortgage Costs

After the crisis, the FHFA was slow to develop plans to release Fannie and Freddie as Congress and two presidential administrations considered various proposals to reshape the companies or replace them with a new system.

FHFA officials say that the new rule is designed so that Fannie and Freddie could survive a 2008-like calamity without needing a new bailout. Critics of the proposal say it requires far too much capital and will end up raising mortgage costs.

As with the preliminary rule that the FHFA proposed in May, the final rule has both a risk-based capital standard and a more-simple leverage-based standard, and Fannie and Freddie are bound by the higher of the two.

Under the preliminary rule as of Sept. 30, 2019, Fannie and Freddie were bound by the leverage standard and would have been required to hold $243 billion. Under the final rule as of June 30, Fannie and Freddie would be bound by the risk-based standard and would have needed $283 billion in order to avoid restrictions on their business activities.

In comments on the proposed rule, Fannie and Freddie both said they might have to increase fees if the rule were finalized. Fannie said it might have to raise fees 0.2 percentage point on average, while Freddie said fees might have to rise between 0.15 percentage point and 0.35 percentage point. A senior FHFA official on Wednesday said that estimates of how the rule could affect mortgage costs are too simplistic and said the agency believed that the new rule is good for borrowers through the economic cycle.

One change that the FHFA did make to the new rule was to increase the capital relief that Fannie and Freddie receive for selling securities that transfer mortgage-credit risk to private investors. Fannie and Freddie executives had said that the proposed rule might make it uneconomical for the companies to issue the so-called credit-risk-transfer securities in many circumstances.

Raising Capital

With the rule finalized, the FHFA, Fannie and Freddie will now turn to how and on what timeline the companies will be able to raise the hundreds of billions of dollars needed to meet the new requirements. They will be expected to develop capital restoration plans, which could include some combination of retained earnings and massive public offerings that could begin as soon as next year.

The FHFA has also begun a push in earnest to amend Fannie’s and Freddie’s bailout agreements with the Treasury Department. A different senior FHFA official said the agency and Treasury Department are actively negotiating an amendment, which the FHFA wants to finalize this year.

The bailout agreements provide Fannie and Freddie with hundreds of billions of dollars in additional capital if they run into trouble, but also require them to send most of their profits to the Treasury above a certain threshold. For the companies to raise the capital needed to meet the new rule, the Treasury Department and the FHFA would need to remove that limit. The FHFA official said the agency wants to permanently end the sweep of profits to the Treasury.

Fannie and Freddie shareholders also hope an amendment to the bailout agreements will somehow reduce the government’s massive ownership stake in Fannie and Freddie. In addition to warrants to acquire nearly 80% of the companies’ common stock, the government owns more than $200 billion in “senior” preferred stock that could be an impediment to future public offerings.

Because the Biden administration is unlikely to share the goal of releasing the companies in the near term, Calabria has sought to strike a last-minute amendment with outgoing Treasury Secretary Steven Mnuchin. It’s not yet clear whether Mnuchin will prioritize finalizing such a complicated agreement in the two months he has left in office.

(Updates with Calabria quote in fourth paragraph.)

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