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a month ago
The issue of Fannie Mae and Freddie Mac having a tiny capital buffer hasn’t escaped the largest shareholder of the two: The U.S. Treasury Department. In remarks this week before a group of Wall Streeters, Treasury Counselor Michael Stegman. The Obama Administration’s point man on all things Fannie and Freddie noted, Despite having only minimal retained capital levels at the GSEs, investors continue to have confidence in their securities due to the ongoing backstop the PSPAs [preferred stock purchase agreements] provide each company.
The substantial remaining capital support left under the PSPAs gives market participants the confidence to buy 30-year GSE securities on a day-in and day-out basis. In 2018, the capital buffer for each falls to zero. So, what happens if there’s a wild swing in interest rates (like we had a few months ago) and one or both of the GSEs posts a loss because of a sharp change in the value of derivatives used for hedging ?
Answer: Uncle Sam steps in and plugs the hole. Why would Uncle do that? Because of the PSPA, but more importantly: if Fannie and/or Freddie have a negative net worth, investors wouldn’t buy their MBS and if investors don’t buy their MBS we would have financial Armageddon.
Of course, there will be no GSE reform bill until we have a new president who hopefully hires someone at Treasury who realizes a zero capital buffer (or a very small one) may not be in the best interest of financial market . It’s no secret that Fannie MBS trades at a premium to Freddie securities, which is why Freddie has to offer sweet guaranty fee deals to its seller/servicers. But in case you’re keeping tabs, Freddie had a stellar February in MBS issuance while Fannie did not. See related story on this website for more details.