Last week’s speech by FHFA Director Mel Watt at the Bipartisan Center  sounded an alarm within the mortgage industry when he stated that there were certain risks the GSEs were facing that were “certain to escalate” the longer the conservatorship continues.
The chief risk, Watt said, was the lack of capital reserves held by Fannie Mae and Freddie Mac, which are required to be reduced to zero by the start of 2018—at which point the GSEs may need another taxpayer-funded bailout similar to the one they received in 2008.
Was Watt’s speech enough to convince the government to end the FHFA’s conservatorship of Fannie Mae and Freddie Mac, which is now in its eighth year, despite insistence from top government officials (namely Treasury Secretary Jack Lew) that the conservatorship will not end during the Obama Administration?
Ralph Axel, rates strategist for Bank of America, thinks so. In a research note, Axel called Watt’s speech “unusual” and said the bank believes that the speech “opens the door to FHFA pursuing a recapitalization plan, eventually leading to the end of the conservatorships,” according to a report from Reuters .
The GSEs required a combined $187.5 billion bailout in 2008, at which time they were taken into conservatorship by the federal government. They returned to profitability in 2012, though an amendment to the bailout agreement requires all GSE profits to be paid to Treasury—which has prompted several lawsuits from Fannie Mae and Freddie Mac investors.
According to the GSEs’ Q4 and full year 2015 earnings statements released last week, Fannie Mae and Freddie Mac have paid a combined $246 billion into Treasury, about $58.5 billion more than they received in the bailout. Axel wrote in his research note, “Now that the FHFA has made the decision to tackle the undercapitalization issue at Fannie/Freddie, we think FHFA will continue to push in this direction and cite its statutory obligation as the driver.”
Watt stated in his speech last week that the GSEs will have no capital buffer by January 1, 2018, and that “a disruption in the housing market or a period of economic distress could also lead to credit-related losses and trigger a draw (on Treasury, i.e. another bailout).”
There are substantial challenges and risks associated with the conservatorship, Watt said, and “these challenges are certainly not going away, and some of them are almost certain to escalate the longer the Enterprises remain in conservatorship.”