Bloomberg News
Releasing Fannie Mae and Freddie Mac from conservatorship could serve a dual purpose for President Donald Trump by both peeling back government involvement in financial markets and freeing up budget capacity for renewed tax cuts.
However, ending government conservatorship of the mortgage securitization giants is easier said than done.
Taken at face value, ending the longstanding arrangement appears to be a windfall proposition. The government would be repaid the $190 billion it has invested in the mortgage market makers since 2008. The move could also see the Treasury Department exercise its stock warrants for the recapitalized companies, potentially bringing in an additional $200 billion or more into the government’s coffers.
Depending on the terms of their recapitalization, the government could also see savings from a reduced role in guaranteeing mortgages — though many in the home lending space hope that is not the case.
In a statement this week, Bob Broeksmit, president and CEO of the Mortgage Bankers of America, said it was imperative that an end to conservatorship be paired with direct government backing of Fannie and Freddie’s mortgage-backed securities moving forward. He warned that failing to do so could drive up the cost of mortgages.
“There needs to be an explicit backstop to Fannie and Freddie [mortgage-backed securities],” Broeksmit said. “We cannot risk bringing Fannie and Freddie out of conservatorship without an explicit guarantee, because there’s no telling how much higher rates will be.”
Fannie and Freddie have a corporate backstop from the Treasury Department in the form of a Preferred Share Purchase Agreement, or PSPA. This mechanism allows the government to recapitalize the companies should they become insolvent. While that mechanism applies to Fannie and Freddie themselves, it does not extend to individual securities bundled by the GSEs. The enterprises themselves guarantee individuals loans, but the degree to which those agreements are subsidized by their close ties to the government is debated.
In Congress, there is little political appetite for an express guarantee of Fannie and Freddie issuances. Some analysts say the credit treatment of the government-sponsored enterprises is unlikely to change so long as government support can be safely assumed. In a note earlier this month, Fitch Ratings said it would maintain its government-grade rating on Fannie and Freddie after conservatorship — but only if the PSPA, or something similar, remains in place.
“If there are mechanisms in place that, from our standpoint, imply ongoing support from Treasury or from the federal government, and if Fannie and Freddie remain an important piece of the overall housing market and the policy of homeownership, as they have been for many, many years, there is a scenario that they would potentially be equalized with the U.S. sovereign rating on a go forward basis,” said Bain Rumohr, a senior analyst at Fitch. “If they exit conservatorship and we don’t get the sense that there is support … or their policy role diminishes, then that’s when we start to look at them on a standalone basis.”
Along with playing a key role in the pricing of individual mortgages, Fannie and Freddie are instrumental to the $11 trillion MBS market — the second largest financial market in the world second only to U.S. Treasury bonds. Some market participants would rather the government left the GSEs alone rather than risk disruption. But the Trump White House has an incentive to get the ball rolling on releasing Fannie and Freddie quickly.
Continuing the expiring provisions of the 2017 Tax Cuts and Jobs Act is a top priority for the administration, but it is an expensive pursuit. The Congressional Budget Office, or CBO, expects the renewal to add $3.7 trillion to the national debt over the next decade. As a result, Republicans need all the offsets they can get, especially if they hope to push a budget bill through on a straight party-line vote.
“There’s a high probability that [when] push comes to shove, there will be a cap on the overall cost of a package on a static basis, and that will send Republicans looking through the couch cushions … looking for potential budget offsets — or what in Washington we call ‘pay-fors,'” said Jeb Mason, partner at the policy consultancy Mindset and a former Treasury official, during an Urban Institute webinar on Fannie and Feddie’s conservatorship last week.
Whether expected proceeds from the release of the government-sponsored enterprises can be counted as an offset is both a technical and political question, one that would be answered through a process known as reconciliation.
In the Senate, where most legislation requires at least 60 votes to avoid being held up by a filibuster, budget reconciliation enables the chamber to advance packages with a simple 51-vote majority. But there are strict rules related to the procedure that could add further complexity to the release process.
“The criteria to get provisions that satisfy the base of the budget law that governs reconciliation can be pretty steep,” said Sarah Binder, a Brookings fellow and political science professor at George Washington University. “When we get to trying to pay for tax cuts, [Republicans] are going to come into a number of hurdles really quickly that probably would make it difficult to get Fannie and Freddie in as ‘pay-fors.'”
Once a topline spending plan is crafted, reconciliation begins with budget committees in both houses instructing other committees on legislation needed to achieve their desired budgetary outcome. But, Binder said there are strict limitations on these provisions.
One of the biggest is the Byrd Rule — named after former Sen. Robert Byrd, D-W.V. — which prohibits committees from attaching non-budget related provisions to the reconciliation package. Binder said this stipulation is meant to prevent lawmakers from using reconciliation to bypass legislative procedures for policy objectives with only incidental impacts on spending or revenue. The arbiter of these various stipulations is the Senate parliamentarian, who serves as an official advisor to the body and is tasked with interpreting its rules and standards.
“You have to thread the needle here a little bit to make sure that the cost or the savings of the provision is really the purpose of the provision,” Binder said. “Otherwise, the parliamentarian is going to raise some red flags.”
Senate rules also prohibit provisions from adding to the federal deficit outside the budgetary window — typically a 10-year span — and require all provisions to have a cost estimate, also known as a score, from the CBO.
Assessing the cost impact of Fannie and Freddie’s conservatorship is tricky for multiple reasons. The first question for scorekeepers is whether the government-chartered corporations are more public or private in nature.
The two Washington entities responsible for tracking governmental expenditures, the CBO and White House Office of Management and Budget, or OMB, take different views on this topic, resulting in divergent readings of the government’s balance sheet.
OMB treats the government-sponsored entities as private companies, so payments from them to the Treasury are counted as revenue. Because of this, the office estimates Fannie and Freddie’s current conservatorship status will reduce the federal deficit by nearly $70 billion between 2025 and 2034 through the mortgage guarantee fees they collect.
Meanwhile, CBO treats the GSEs as part of the government. Cash receipts from them are deemed intergovernmental transfers, meaning they are neither expenses nor revenues. Based on its fair value accounting method — which discounts future cashflows from GSE guarantees over their lifespan to account for inflation — Fannie and Freddie represent a roughly $50 billion liability for the government over the next decade.
Ultimately, the CBO’s estimate is what drives decision making during reconciliation. That creates another set of complications because the office is designed to evaluate legislation as it is developed and implemented. But it appears unlikely that the recapitalization of Fannie and Freddie will be handled legislatively, said Robert Zimmer, a strategic consultant and former House Financial Services Committee staffer.
“Both parties have basically signaled to the last two administrations — and now a third — that they wash their hands like, ‘Do what you need to do,'” said Zimmer, who runs his own consulting firm and works for the mortgage lender group Community Home Lenders of America. “They reserve the right to critique whatever the administration does, but there’s no one in Congress saying, ‘Halt, nope — Treasury, don’t do anything. We’re going to legislate.’ There’s no one.”
Instead, Zimmer said, the process is likely to be run directly by the Treasury and the Federal Housing Finance Agency, which regulates the GSEs and oversees the conservatorship. But that approach would not go through CBO scoring in real time.
During the Urban Institute’s webinar, Justin Humphrey, chief of the CBO’s Finance, Housing, and Education Cost Estimates Unit, said the office does not have a mechanism for analyzing administrative actions as they are being developed. Instead, his group looks at finished works and updates its baseline expectations accordingly.
“If the administration announced a clear and official action … for example, an end date for the conservatorships, our baseline would be updated to take on those facts and our future cost estimates of any legislation would also take on board any of those administrative actions that had been announced by the Congress,” Humphrey said.
While these hurdles are not insurmountable, they will take time — something that will be in short supply for this year’s budget cycle. Trump is due to submit his budget request on Monday, Feb. 3 and June 30 is the deadline for congressional action on the related bills. The process of recapitalization and release would not have to start by then, but the administration would need a solid plan in place to have it factored into reconciliation.
In theory, the administration could pick up where it left off in 2020, but the personnel involved would be different and their views on the matter are unclear.
Scott Bessent, Trump’s pick for Treasury secretary, was not asked about the GSEs during his confirmation hearing with the Senate Finance Committee, and President Trump only announced his nominee for FHFA director last week. His choice, Bill Pulte — a private equity executive and grandson of William Pulte, founder of the homebuilding firm PulteGroup — has not weighed in publicly on the prospects of releasing Fannie and Freddie.
With so many considerations to be made and details to be ironed out, many are skeptical that the administration will be able to hammer out a release plan in time for this budget cycle.
“As they start peeling back the onion of bringing them out of conservatorship, there’s going to be a lot of issues they have to get their arms around,” said Ted Tozer, a nonresident fellow with the Urban Institute and a former president of Ginnie Mae.
Tozer said the effort begun under former FHFA Director Mark Calabria to build up capital at Fannie and Freddie has gone a long way toward positioning the enterprises to eventually stand on their own. But, he noted, that the housing finance market has changed dramatically in recent years in ways that make this an inopportune moment for a big policy adjustment.
Despite recent cuts to the Federal Reserve’s policy rate, mortgage rates have actually risen since last fall — a trend driven by concerns over deficits and inflation, as well as secular developments in the MBS market. In light of this, Tozer said there is much work to be done to avoid worsening the nation’s affordability crisis.
“Even though the Trump administration is excited about the concept of this as a ‘pay-for’ and creating a big injection of revenue in the government, we’re a long way from actually looking through all the things needed to get to that point — unless they’re willing to just let the chips fall where they may,” Tozer said. “But if that’s the case, it’s going to cause tremendous havoc in the housing market. I don’t think the Trump administration wants to have increased interest rates and hampered access to credit in a market where people are already complaining about how expensive it is to buy a home.”
