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FHFA Inspector General Cautions Profitability of GSEs Might Not Continue

money-deterioratingIn a white paper released Wednesday titled "The Continued Profitability of Fannie Mae and Freddie Mac is Not Assured," the Office of Inspector General of the Federal Housing Finance Agency (FHFA) warned that the profitability of the two GSEs may not continue due to their having to rely on core earnings for profits in the future.

The combined profits of the two GSEs totaled $135 billion in 2013 largely due to non-recurring tax-related items and legal settlements, which accounted for 60 percent of the profits. Without the income from the non-recurring items and settlements in 2014, the profitability of the two Enterprises shrunk to a combined $22 billion. Only 40 percent of the profits in 2013 came from core earnings, compared to 55 percent in 2014.

The white paper suggested that the profitability of the GSEs in is jeopardy because, aside from missing the income from non-recurring items, the two Enterprises are legally required to reduce their investment portfolios, thus shrinking another source of income. Also, Fannie Mae and Freddie Mac cannot legally accumulate a financial cushion to absorb future losses – they must pay a dividend to Treasury each quarter equal to the excess of their net worth over an applicable capital reserve amount, according to the white paper. That capital buffer is currently $1.8 billion and is required to be reduced by $600 million per year until it reaches zero by 2018. Should the GSEs' losses exceed their capital buffer, they would require another draw on Treasury.

"Fannie Mae reports that it expects to remain profitable for the foreseeable future; however, it acknowledges that a decrease in home prices or changes in interest rates, combined with provisions of their agreements with Treasury that require the reduction of their retained asset portfolios, could lead to losses," wrote Acting Deputy Inspector General for Evaluations Kyle Roberts in the white paper. "Thus, if these losses result in an Enterprise reporting a negative net worth, that Enterprise would be obligated to draw on Treasury’s funding commitment."

The white paper stated that a stress test conducted by the FHFA in April 2014 found that under economic conditions similar to those akin to the recent financial crisis, the two GSEs would require a draw on Treasury of $84.4 billion or $190 billion depending on the treatment of deferred tax assets.

The FHFA OIG's white paper was the second report released this week discussing the declining profitability of Fannie Mae and Freddie Mac. On Monday, the Urban Institute published a research brief entitled "What to Make of the Dramatic Fall in GSE Profits" and examined the likelihood of Freddie Mac having to take another draw on Treasury, which it has not done since 2012.

Fannie Mae and Freddie Mac required a combined bailout of $188 billion in 2008 after the government seized control of them. The two GSEs returned to profitability in 2012. The future of the two GSEs has been a hotly contested topic in Washington as well as in the rest of the housing industry. Both parties appear to want to wind down the FHFA's conservatorship of the two, but cannot agree on what, if anything, should replace them as well as what role the government should play in housing, if any.

"Absent Congressional action, or a change in FHFA’s current strategy, the conservatorships will go on indefinitely," Roberts wrote in the FHFA OIG white paper. "The Enterprises’ future status is beyond their control. At present, it appears that Congressional action will be needed to define what role, if any, the Enterprises play in the housing finance system."

U.S. Senator Bob Corker (R-Tennessee) co-sponsored legislation along with Senator Mark Warner (D-Virginia) in 2013 to eliminate GSEs Fannie Mae and Freddie Mac and replace them with a private insurance company system with a government backstop. The bill, known as the Housing Finance Reform and Taxpayer Protection Act of 2014 (S.1217), passed in the Senate Banking Committee by a vote of 13 to 9 in May 2014.

"Today’s report strengthens my long-held belief that one of the biggest issues for Congress to address, and the last major unfinished business from the 2008 financial crisis, is passing comprehensive legislation to wind down Fannie Mae and Freddie Mac," Corker said in reaction to the FHFA OIG's white paper. "Much bipartisan effort has been put forth, and for Republicans to have a majority in Congress and not take action would be completely irresponsible."

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.

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