The country’s two secondary mortgage market companies Fannie Mae and Freddie Mac will no longer have to borrow money from the U.S. Treasury to make their quarterly dividend payments to the federal government (in effect borrowing from the Treasury so they can make payments back to the Treasury), a move that could help reassure investors that the companies are less likely to tap out their federal credit lines any time soon. But the dividend requirement, which diverts money away from the mortgage market, remains in effect.
If the whole idea of Fannie and Freddie borrowing from the Treasury to make dividend payments to the Treasury makes you scratch your head, it’s because of the way the federal government structured its conservatorship of the two companies in the wake of the financial meltdown in 2008. At the time the Federal Housing Finance Agency (FHFA) stepped in as conservator of the two companies, which were burning through their capital reserves to compensate investors for all their loans going bad, the federal government agreed to inject capital into the companies in exchange for ownership of the companies’ preferred stock. The idea was that the companies would pay back the government for its assistance through their preferred stock dividend payments.
On paper the idea seems reasonable, but in practice it had the effect of forcing the companies to draw down from their capital lines to the U.S. Treasury to make their dividend payments whenever their quarterly performance wasn’t sufficient to generate enough funds for their 10-percent dividend payment.
The arrangement never made much sense to NAR, which since 2010 has been calling for Treasury, at a minimum, to reduce the dividend requirement so the companies would have more money with which to stabilize the mortgage market. As then-NAR President Ron Phipps said in testimony before the Senate Banking Committee in early 2011, the dividend payment is “punitive” and should be reduced to 5 percent from 10 percent if not eliminated altogether. “It makes no apparent sense for the Treasury Department to transfer amounts to the GSEs so they, in turn, will have enough money to make the dividend payment back to the Treasury,” he said.
Under the change Treasury announced today, it would replace the 10 percent quarterly dividend requirement with a quarterly “sweep” of the companies’ profits, whatever those profits are, making it unnecessary for the companies to make draws on their federal lines of credit to make up for any gap in their 10-percent dividend obligation. Under this arrangement, Treasury might get more funds than it would some quarters but in other quarters it might get less, but now it won’t be necessary for the companies to make up the difference by drawing down on their lines of credit.
As Treasury puts it, “The agreements will replace the 10 percent dividend payments made to Treasury on its preferred stock investments in Fannie Mae and Freddie Mac with a quarterly sweep of every dollar of profit that each firm earns going forward.”
This doesn’t necessarily mean the companies’ obligations to Treasury are any less; it just means they no longer have to make draws on their credit lines, reducing the chance they’ll max out on those lines in the near future. That, at a minimum, can be expected to provide some long-term reassurance to investors about market stability than would otherwise have been the case.
Treasury’s announcement also touched on another change, which is speeding up a requirement that the companies shrink the size of their portfolio of retained loans. Under the original conservatorship agreement, the companies were to wind down their portfolios by 10 percent a year until they had shrunk their portfolios to $250 billion by 2022. Now they’re to shrink them by 15 percent a year and get to $250 billion four years sooner, by 2018.
Treasury says these changes are aimed at winding down the federal government’s involvement in the companies more quickly, although it doesn’t say anything more about what it’s plans are for the wind-down.
“With today’s announcement, we are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac,” says Michael Stegman, counselor to the secretary of the Treasury for housing finance policy, “while continuing to support the necessary process of repair and recovery in the housing market.”
NAR’s position is that the former structure of the secondary mortgage market companies, in which gains accrued to the companies’ private shareholders while losses accrued to taxpayers, is unacceptable and whatever entities replace them should be government-chartered and non-profit and should support, with explicit government backing, a private mortgage-lender dominated market.
With today’s announcement, we get no further clarity on what the federal government is thinking of doing, but we do see that it recognizes, as NAR has been saying for the last two years, that the 10-percent dividend requirement was working at cross purposes with the companies’ goals.