Pay Up

Freddie Mac & Fannie Mae Get the Squeeze

The U.S. Treasury is rolling out new rules to get its loans back faster. Matthew Zeitlin explains.

AP Photo

The biggest recipient of taxpayer dollars in the federal spending spree designed to avert economic calamity wasn’t Citigroup, or AIG, or even General Motors and Chrysler. It was the two government sponsored mortgage corporations–Fannie Mae and Freddie Mac–whose relentless pursuit of market share and profits led to massive losses followed by a government takeover in 2008 and a staggering 12-figure infusion of taxpayer dollars.

Fannie and Freddie remain under the control of their regulator, and today the Treasury Department announced stricter terms in an effort to recoup as many taxpayer dollars as quickly as they can.

The new terms of federal support for Fannie and Freddie alter the four-year old bailout by requiring the companies to reduce their gargantuan portfolio of mortgages at a faster pace and to hand over all their profits to the taxpayer. The second provision is designed to end the backwards-seeming process that sometimes required the companies to take money from the government in order to pay the mandatory 10 percent dividend on the preferred shares that the Treasury purchased as part of the bailout in 2008.

Now, instead of making the dividend payments, the companies will simply hand over their profits to the taxpayer. One reason Treasury gave for this change is so that Fannie and Freddie “will be wound down and will not be allowed to retain profits, rebuild capital, and return to the market in their prior form.”

The initial bailout had two main components–the shares the Treasury purchased in its takeover obligated Fannie and Freddie to pay quarterly dividends, but the companies also received the right to draw money from the Treasury in case they needed it. So, in those quarters when the profits weren’t enough to cover the dividend, the government-sponsored enterprises would end up in the circular situation of taking taxpayer dollars in order to pay back the U.S. government.

Now, though, the U.S. is able to scrap the required dividend and start hoovering up all the profits because the fortunes of Fannie and Freddie have taken a turn for the better. As the housing market has started to stabilize, the mortgage giants’ portfolios have improved, and they’re starting to see relatively big profits. The more-or-less worthless mortgages they bought up before their bailout are not performing as badly as they once were, and are starting to become a smaller portion of their overall mortgage holdings. In addition, the mortgages they bought after being brought into conservatorship conform to higher standards and so are performing much better.

In Fannie Mae, for example, mortgages originated since 2009 make up more than 58 percent of their total portfolio and have a default rate under 0.3 percent. Mortgages purchased just a year earlier, in 2008, have a default rate of 3.1 percent, while around 10 percent of 2007 and 2006 mortgages have gone bad. Now, some of this is due to the fact that newer mortgages will always default less, but the sharp divergence in the performance of the mortgages is also due to Fannie Mae adopting higher standards for what they will purchase. And with better standards and an improving housing market, the government-sponsored enterprises might transition from being a vacuum cleaner for taxpayer dollars into smart, conservative mortgage companies that can both support the overall mortgage industry and start to recoup their massive government support.

Recent financial results indicate that this might actually happen. Fannie Mae had a profit of $5.1 billion in the second quarter of this year, bringing it up to a total of $7.8 in the first half of 2012. Had the current arrangement been in place last quarter, Fannie would have handed over all of the $5.1 billion to the Treasury instead of a $2.9 billion dividend payment. In total, Fannie has drawn $116.1 billion and paid $25.6 in dividends.

Freddie Mac also had an impressive second quarter, bringing in a $3 billion profit that let them to make on top of its $1.8 billion dividend payment. Their first quarter profit was $577 million. In total, Freddie has drawn more than $72 billion from the Treasury while making just over $20 billion in dividend payments.

Treasury’s more aggressive stance toward getting money back from their taxpayer-supported wards does not just apply to the government-sponsored mortgage companies. The other giant taxpayer bailout, TARP, has not only already turned a profit for the taxpayer, but yesterday, the Treasury department announced yet another auction of bank shares on the open market. This is part of a continuing strategy for those banks that have not been able–or have not been willing–to buy back the shares the government purchased when they bailed them out. This auction will be for shares in five banks and is scheduled for later this month.