The Inspector General for the Federal Housing Finance Agency (FHFA) recently reported that Fannie Mae and Freddie Mac might need more government bailouts if housing markets decline. The problem: lack of capital reserves to serve as a buffer against future losses.
The FHFA’s warning wasn’t the first. Last month on an earnings call, Fannie Mae CEO Tim Mayopoulos also warned that the company’s lack of capital “increases the likelihood that Fannie Mae will need additional capital from Treasury at some point.”
This problem is no accident: It is the result of a deliberate decision in 2012 by the Treasury Department to sweep Fannie’s and Freddie’s profits into the federal government’s coffer. Treasury’s “net worth sweep” is illegal and economically dangerous. It needs to end.
ENLARGEIt’s not difficult to understand concerns over another bailout of Fannie and Freddie. In 2008 Treasury rescued the mortgage giants from insolvency, ultimately with $187 billion of taxpayer money. Treasury was acting under the 2008 Housing and Economic Recovery Act, which created a framework for the government to decide what to do with the two companies.
The government could have put them into receivership, but nobody wanted the taxpayer to assume the $5 trillion in liabilities on the their balance sheets, and the U.S. needed to reassure bondholders (mostly foreign) that they weren’t about to be wiped out. And so, after being rescued, the two companies were placed into a conservatorship administered by the FHFA, with a mandate to “conserve and preserve” Fannie and Freddie for their shareholders while the companies rebuilt their capital.
Nearly seven years later Fannie and Freddie remain in conservatorship. As of Dec. 31, 2014, they have repaid the government $227 billion—roughly $40 billion more than they were originally loaned. Yet instead of allowing the companies to build a capital reserve like any large financial institution, the Obama administration is stripping both companies of 100% of their profits. This is based on a change to the conservatorship agreement made by Treasury in 2012 requiring Fannie and Freddie to pay a 100% dividend to Treasury each quarter.
The government had every right to impose harsh terms on private investors when it saved the two companies from failure in 2008. It did that by taking 79% of the company from private stockholders and taking senior preferred stock with a 10% dividend.
No problem so far. But for the government to come back four years later and unilaterally change the terms of its deal is troubling—and it will cause significant problems for regulators in getting the private sector to help in a future crisis.
Fannie and Freddie’s investors are justifiably outraged, and some of them have sued the government for its actions. But the public should also be concerned. By denying Fannie and Freddie the ability to accumulate capital, the government is putting taxpayers on the hook for any future losses they may incur.
The Obama Treasury is ignoring the threat. A senior Treasury official, Michael Stegman, told a Goldman Sachs conference earlier this month that recapitalizing Fannie and Freddie would come at taxpayer “expense.” The only logical reading of this analysis is that a dollar going to rebuilding capital is one less dollar going into the Treasury’s general fund. Mr. Stegman has it backward: The risk of another massive taxpayer bailout, arising from undercapitalization, is precisely why Treasury must end the net-worth sweep and allow Fannie and Freddie to emerge from the limbo of conservatorship.
Some would argue that recapitalizing Fannie and Freddie would itself present a threat to the taxpayer, given the troubled history of these institutions and the role they played in the financial crisis. This is a farcical argument: We can allow the two government-sponsored enterprises to recapitalize and then, if policy makers develop a better alternative, wind them down in an orderly liquidation process.
Policy makers can disagree about what future role there should be for Fannie and Freddie in housing finance. But there should be no disagreement about the need to observe and respect the rule of law.
Mr. Isaac, a former chairman of the Federal Deposit Insurance Corp., is a senior managing director at FTI Consulting. He advises Investors Unite, a shareholder group opposed to the Treasury’s sweep of Fannie Mae and Freddie Mac profits.