.@FannieMae & @FreddieMac conservatorships, 2 Cash Cows $fnma $fmcc James Lockhart, then Director of the Federal Housing Finance Agency (FHFA), stated that Fannie Mae and Freddie Mac were adequately capitalized on July 8, 2008. This statement was made during a time when there were growing concerns about the financial health of these government-sponsored enterprises (GSEs), but before the decision to place them into conservatorship was announced on September 7, 2008. Fannie Mae (FNMA): Before conservatorship, Fannie Mae had around 45 billion dollars in cash and cash equivalents. Freddie Mac (FMCC): Freddie Mac had approximately 19 billion dollars in cash and cash equivalents. Conservatorship: On September 7, 2008, Fannie Mae and Freddie Mac were placed under conservatorship. This meant the government took control of the operations of these entities to stabilize them, but they were not nationalized. The intent was to preserve their assets and support the housing market. When the Government took control they changed the accounting practices to: Mark-to-Market Accounting: Definition: Mark-to-market or fair value accounting involves valuing assets at their current market value rather than their historical cost or the value at which they were purchased. Impact During Crisis: During the financial crisis, the housing market plummeted, causing the market value of mortgage-backed securities (MBS) and other mortgage assets held by Fannie Mae and Freddie Mac to drop significantly. This accounting practice led to the recognition of large unrealized losses on their balance sheets. This accounting practice forced the Government Sponsored Entities (GSE’s) to borrow money from the Treasury to fill the temporary hole. Initial Losses: When the market crashed, the value of many assets held by Fannie and Freddie was below their purchase price. Mark-to-market forced these companies to recognize these declines as losses on their books, even though the mortgages were still being paid. Similar to a person who bought a house for 400k and several years later the value went down to 200k and that person is forced to take a 200k loss even though they are still making mortgage payments and over time the value comes back. Government's Financial Strategy: The Government made a deal with itself (FHFA & US Treasury) to take 79% ownership of Fannie Mae and Freddie Mac as collateral for the loans . Senior Preferred Stock Purchase Agreements (SPSA): When Fannie Mae and Freddie Mac were placed into conservatorship in September 2008, the U.S. Treasury agreed to provide financial support through these agreements paying them a 10% Dividend on borrowed funds. Under the terms of the SPSA, the Treasury received senior preferred stock in exchange for its commitment to provide capital to the GSEs as needed to maintain a positive net worth. This was designed to stabilize the companies and ensure they could continue operations. Under the Senior Preferred Stock Purchase Agreements (SPSA) initiated during the financial crisis in 2008, Fannie Mae and Freddie Mac drew funds from the U.S. Treasury to cover their net worth deficits. Here's how much they borrowed: Fannie Mae (FNMA): Fannie Mae drew approximately $119.8 billion from the Treasury under the SPSA. Freddie Mac (FMCC): Freddie Mac drew approximately $71.3 billion. Thus, together, Fannie Mae and Freddie Mac borrowed around $191.1 billion from the U.S. Treasury under these agreements to maintain their solvency during and post the 2008 financial crisis. Fannie Mae and Freddie Mac's financial turnaround involves several key accounting and financial concepts: Deferred Tax Assets and Losses: Losses During the Crisis: As the housing market collapsed, FNMA and FMCC faced significant losses due to the decline in the value of their mortgage holdings. These were unrealized losses due to mark-to-market accounting practices. Deferred Tax Assets: The companies could claim tax deductions for these losses. Since they were not profitable, they couldn't immediately benefit from these deductions. However, under U.S. tax law, they could use these tax losses to offset future income, creating deferred tax assets. Deferred tax assets are recorded on the balance sheet and represent potential reductions of future tax payments when the companies become profitable again. Reversal of Tax Credits: When the housing market began to recover, the value of their assets increased. This meant the unrealized losses, which had been written down, started to reverse. As the value of their assets went up, FNMA and FMCC could now use their deferred tax assets, effectively reducing their taxable income for the years when they turned profitable. 2012 and Profits: Market Recovery: By 2012, the U.S. housing market had bottomed out and was starting to recover. Home prices rose, delinquency rates fell, and the overall financial health of these institutions improved. Reversal of Deferred Tax Assets: The recovery in asset values meant that the companies no longer needed to reserve as much for potential losses. This led to a situation where previously deferred tax credits could now be applied against the current income, significantly reducing their tax liability. Profitability: With the housing market on an upward trend, FNMA and FMCC started to report significant profits. The effective use of deferred tax assets against their income further boosted their reported net income. Net Worth Sweep Impact: The timing was unfortunate for shareholders due to the net worth sweep implemented in 2012, which required that nearly all profits be sent to the U.S. Treasury. This policy change meant that while the companies were profitable, the shareholders did not directly benefit from this profitability as the profits were essentially redirected to repay the government for the bailout funds. Jim Parrott, who was a housing policy adviser in the Obama administration used the phrase "golden age of prosperity" to describe the potential financial health of Fannie Mae and Freddie Mac just before the implementation of the net worth sweep in 2012. The Government made a deal with itself (FHFA and US Treasury) to amended the SPSPA terms in 2012 to a "net worth sweep", where nearly all profits (after a small capital reserve) were directed to the Treasury, essentially acting as a dividend to repay the bailout funds. This net worth sweep was implemented every quarter and did not count as payback to the GSE’s loans. In 2013, following the implementation of the net worth sweep in 2012, the total amount of money swept from Fannie Mae and Freddie Mac to the U.S. Treasury was: Fannie Mae sent approximately $59.4 billion to the Treasury. Freddie Mac sent approximately $48.7 billion to the Treasury. Total Amount Swept in 2013: The combined total from both GSEs was about $108.1 billion. This figure represents the profits of these companies that were transferred to the Treasury under the new terms of the Senior Preferred Stock Purchase Agreements, rather than being used to build capital or pay dividends to other shareholders. Fannie Mae and Freddie Mac, after being placed into conservatorship, repaid the U.S. Treasury significantly more than the amounts they borrowed. Here's an overview of the repayments: Fannie Mae: Before the Net Worth Sweep: Fannie Mae repaid the Treasury through dividends on the senior preferred stock at a 10% dividend rate. Net Worth Sweep: Implemented in 2012, this amendment required Fannie Mae to pay all profits (after a small capital reserve) to the Treasury. Total Repayments: By the end of 2019, Fannie Mae had paid back $169 billion in dividends (which includes both before and after the net worth sweep). Freddie Mac: Before the Net Worth Sweep: Similar to Fannie Mae, Freddie Mac paid dividends before the sweep. Net Worth Sweep: Also implemented in 2012, requiring Freddie Mac to send all profits to the Treasury. Total Repayments: By the end of 2019, Freddie Mac had paid back $132 billion in dividends. Total Combined Repayments: By the end of 2019, the combined amount paid back by both Fannie Mae and Freddie Mac to the Treasury was around $301 billion on a $191.1 billion loan. Agreement in 2019: On September 30, 2019, an amendment to the Senior Preferred Stock Purchase Agreements (SPSPAs) was announced by the U.S. Department of the Treasury and the Federal Housing Finance Agency (FHFA). This amendment allowed Fannie Mae and Freddie Mac to retain more of their earnings to build capital, rather than sweeping nearly all profits to the Treasury. Capital Retention: The agreement permitted Fannie Mae to retain up to $25 billion in capital and Freddie Mac up to $20 billion. This was part of a broader plan to allow these entities to recapitalize and potentially move towards exiting conservatorship. In return for allowing capital retention, the liquidation preference of the Treasury's senior preferred stock in each GSE increased by the amount of capital they were allowed to retain, ensuring that the Treasury's position was not financially disadvantaged by this change. This move was seen as a step towards housing finance reform, aiming to eventually reduce the government's involvement in these companies. The policy shift under Mnuchin allowed for the GSEs to start rebuilding their capital reserves, which was crucial for their financial stability and for future considerations of releasing them from conservatorship or restructuring their operations. However, despite this change, significant steps towards full privatization or a comprehensive legislative reform were not completed during Mnuchin's term. Fannie Mae reported $4.0 billion net income for the third quarter of 2024, with net worth reaching $90.5 billion as of October 31, 2024 Freddie Mac reported $3.1 billion net income for the third quarter of 2024, with a net worth reaching $56 billion as of October 30, 2024. Fannie Mae's total assets were reported to be approximately $4.3 trillion up to early 2024. At minimum to exit conservatorship they will need 2.5% of $4.3 trillion or approximately $107.5 billion in retained earnings. Freddie Mac's total assets as of the end of 2023 were about $3.2 trillion. At minimum to exit conservatorship they will need 2.5% of $3.2 trillion or approximately $80 billion in retained earnings. Fannie Mae and Freddie Mac could potentially use a consent decree with the U.S. Treasury as one of the mechanisms to facilitate an exit from conservatorship. How a Consent Decree Might Be Used: Negotiation: The Federal Housing Finance Agency (FHFA), acting as conservator, along with Fannie Mae and Freddie Mac, would negotiate with the U.S. Treasury to establish terms under which the GSEs could exit conservatorship. This negotiation might involve the companies' capital levels, operational reforms, guarantees, or other conditions. Terms of the Consent Decree: Capital Requirements: The decree might set out specific capital levels Fannie Mae and Freddie Mac must achieve or maintain before exiting conservatorship. Operational Changes: It could require operational reforms or updates to ensure safety and soundness, potentially including changes in risk management, governance, or business practices. Government Stake: There could be terms regarding the Treasury's senior preferred stock, possibly allowing for its redemption, conversion to common stock, or some other form of compensation or restructuring. Monitoring and Compliance: The decree might establish a period of oversight where an independent monitor or the FHFA itself would ensure compliance with the terms. Exit Strategy: It would detail how the GSEs would transition out of conservatorship, possibly involving a step-by-step process of reducing government control. Legal Framework: The consent decree would need to be filed with and approved by a federal court. It would carry the weight of a court order, making it legally enforceable. Public and Congressional Involvement: Given the public interest and the significant role these GSEs play in the housing market, input from Congress might be necessary or at least politically advisable. The terms might need to align with legislative intent or could prompt new legislation. Implementation: Upon court approval, the GSEs would operate under the terms of the decree, which could include a timeline for when they must achieve certain milestones to be considered for release from conservatorship. Benefits: This mechanism could provide a structured, legally enforceable pathway out of conservatorship, offering clarity to investors, markets, and stakeholders about the future governance and financial strategy of Fannie Mae and Freddie Mac. Complexity: The terms need to balance the interests of taxpayers, shareholders, and the housing market. Political Considerations: Changes to the structure of these GSEs often meet with political resistance or require political capital. Legal Challenges: Shareholders or other stakeholders might challenge the terms if they believe their interests are not adequately protected. Endgame: Upon fulfilling the terms of the decree, Fannie Mae and Freddie Mac could petition U.S. Treasury to end the conservatorship formally, potentially leading to a return to some form of private ownership or operation.