No Matter Who Becomes President, Fannie and Freddie Won’t Be Exiting Conservatorship

Despite recent remarks from Mark Calabria, former FHFA head (FHFA being Fannie and Freddie’s regulator), that a new Trump administration would provide Fannie Mae and Freddie Mac with a pathway to independence, the reprivatization of the two mortgage giants is doubtful. Let’s discuss these obstacles in more detail. 

Capital Requirements

Capital requirements remain a substantial barrier. Despite recent agreements allowing Fannie Mae and Freddie Mac to build a 25-billion-dollar capital buffer, they still need more capitalization to exit conservatorship. According to the Federal Housing Finance Agency (FHFA), Fannie Mae would require approximately $116.5 billion and Freddie Mac $82.6 billion in additional capital before exiting conservatorship. Retained earnings alone are deemed insufficient, necessitating significant private capital investment, which is complicated by the senior preferred stock agreements with the U.S. Treasury that prioritize the Treasury’s claims on the companies’ earnings. FHFA does not want the GSEs to work with retained earnings alone. The regulator wants the GSEs to be subject to the market discipline associated with raising capital. 

Meanwhile, any stock offering that could raise the necessary amount would be larger than the greatest public offerings in history (Top IPOs). Given the government’s history of taking over the GSEs at will, would many investors be willing to buy in? A great many institutional investors might worry that investing in Fannie and Freddie would invite government interference in their affairs. Complicating things further, Fannie and Freddie would have to raise these record-breaking amounts of capital at roughly the same time, all in a high interest rate environment, reducing Fannie’s profits and making raising capital more difficult. After all, allowing one of the GSEs out of conservatorship without allowing the other would not work politically or economically; it would look like one of the GSEs was being given favorable treatment. Furthermore, ironically enough, the one still under conservatorship would be able to receive credit on more favorable terms than the other because of its more direct government backing.  

The Profit Sweep

While Fannie and Freddie have returned to profitability, they are only allowed to keep their profits up to 25 billion and 20 billion a year each; after Fannie reaches that amount, the profit sweep goes into effect again. This complicates the path to privatization, as ongoing government involvement and profit sweeps will deter potential private investors​ )​. Additionally, a source of revenue that does not require raising taxes may prove too juicy for the government to give up in the long run. Of course, the amount of earnings Fannie is allowed to retain is larger than Fannie sees in most years—where typical profits are a “mere” 16 billion. However, profits are down recently, reaching only about 12.9 billion last year. That said, if FHFA would allow Fannie to work with retained earnings alone, six good years might get them the capital they need, but as we discussed above, FHFA wants the GSEs to raise funds. 

The Legal Landscape

The legal landscape presents another hurdle. The agreement for conservatorship states that no exit can occur until all significant litigation related to the conservatorship is resolved. This stipulation ensures that legal uncertainties and potential liabilities must be settled before any transition can be considered, adding another layer of delay​ (Housing Wire)​. However, while under conservatorship, Fannie does not have the freedom or resources to resolve these legal issues through settlements. As Fannie and Freddie approach privatization, we can expect those legal contests to heat up further.

The Political Landscape

Political factors also play a critical role. The decision to end conservatorship involves significant policy changes that require consensus among various stakeholders, including Congress, the FHFA, and the Treasury. Historically, there has been considerable debate over the future of these government-sponsored enterprises (GSEs), with differing opinions on the best approach to reform and privatization. This political gridlock further stalls progress toward ending conservatorship​ (HousingWire).

Let’s consider these political dynamics in more detail: We have only seen the same party hold political power for more than eight years once in the last 73 years. If Trump or Biden (or Kamala) wins, it is unlikely that there won’t be a considerable voter reaction towards the other party in four years’ time given the polarization in our politics. We have seen a tendency for the other party to take control of Congress in the midterms following a presidential win. Furthermore, a split Congress—with one side controlling the House and the other the Senate—could also hamper efforts to release the GSEs from conservatorship. In short, we are unlikely to have a united government long enough to carry out a successful privatization. Furthermore, the current system appears to work “well enough.” No powerful constituency is pushing for the GSEs’ privatization either. Why would politicians want to get involved with such a thorny problem when they can just ignore it? How would the issue of GSE privatization ever become a priority given all the chaos in the world including an ongoing war in Europe, inflation, and a host of other issues? Indeed, with the inflation fight pushing mortgage rates up, it is unlikely that the government would want to give up the influence on mortgage rates the GSE conservatorship grants them no matter which party takes control of Congress.

Concerns about the Broader Housing Market

Lastly, the broader housing market dynamics influence the status of conservatorship. The GSEs play a crucial role in providing liquidity to the mortgage market, and any drastic changes could impact market stability and accessibility to affordable housing. Policymakers must balance the need for GSE reform with the potential risks to the housing market, making a cautious approach more likely. Even if they agree in principle about the need for privatization, and many do not, there will be protracted fights about which plan is best. In short, there will not only be fights about privatization but there will also be fights about how to go about it. A few issues could be 1) the amount of private capital that must be raised, 2) whether the government line of credit should continue, 3) the extent of FHFA’s regulatory powers once they both exit conservatorship, etc.  (HousingWire)​.

In summary, the combination of substantial capital requirements, profitability and financial stability issues, legal challenges, political complexities, and broader market considerations make the exit of Fannie Mae and Freddie Mac from conservatorship an intricate and prolonged process. While incremental steps have been taken toward this goal, significant hurdles remain that likely ensure the continuation of their conservatorship for the foreseeable future no matter who wins in the upcoming elections. The complexities could stretch the process out for well over a decade if not longer.

Read more: Two FHFA announcements

Franklin Carroll

Franklin Carroll is Kukun's VP of Modelling and Analytics; After finishing his studies at the University of Chicago, he worked at Fannie Mae where he helped build Collateral Underwriter, roll out the Value Verify initiative, and specialized in collateral related and credit related policy.

Published July 23, 2024