(Reuters) - The Trump administration has released a report laying out its vision for overhauling Fannie Mae and Freddie Mac, which guarantee over half of all U.S. mortgages and have been under government control since their bailout during the 2008 financial crisis.
The report issued by the Treasury Department on Thursday lays out a series of potential legislative and administrative reforms that could pave the way to ending the conservatorship of the mortgage giants. They fall into three areas: defining a limited role for the federal government in the housing system, protecting taxpayers against future bailouts, and promoting competition in the housing market.
Here are some of the highlights:
The Treasury’s preference is for Congress to do much of the heavy lifting on overhauling the U.S. housing finance market.
Most notably, it calls for lawmakers to create an explicit government guarantee for the companies’ mortgage-backed securities after they exit conservatorship. Currently, Fannie and Freddie are majority-owned by the U.S. Treasury, which serves as a de facto backstop. That would end if the Treasury divested its holdings and only Congress has the power to create a guarantee in its place.
Separately, the Treasury also wants Congress to create new charters for competitors to Fannie and Freddie, to foster competition and reduce the risk the pair pose to the financial system. The catch is that housing lobbyists do not expect Congress to take any material legislative action ahead of the 2020 presidential election.
Currently, Treasury holds warrants representing 80% of Fannie and Freddie’s common stock, as well as senior preferred stock. Under the terms of the preferred stock agreement, Treasury is guaranteed a 10% dividend and sweeps the firms’ quarterly net profits into its coffers. That arrangement has left Fannie and Freddie with just around $3 billion of capital each, leaving taxpayers exposed to future bailouts.
The report calls for rebuilding the pair’s capital, but does not provide a target figure, only that they should have enough to operate as a going concern following a severe stress scenario. The report also does not provide a clear plan for raising capital, but indicates the firms may start the process by beginning to retain earnings above the permitted $3 billion. It does not recommend an immediate end to the net worth sweep and stresses any such arrangement will have to be carefully negotiated with the Federal Housing Finance Agency, which oversees the firms. It adds that regulators will assess “the full range of strategic options,” suggesting that options beyond retained earnings and an initial public offering may be considered.
The Treasury does stipulate, however, that the new capital structure would require “significant first-loss private capital,” meaning private investors would bear any potential losses before taxpayers. Taxpayers should only be on the hook in a catastrophic situation, the report says.
Part of the Treasury’s report aims to curtail Fannie and Freddie’s activities, thereby lowering their risk to the broader financial system and eliminating what the administration says are unfair advantages over the private market.
As part of that effort, the report recommends Congress or regulators draw-up strict new capital, liquidity, and resolution planning requirements for the pair. The report also calls for a review of Fannie and Freddie’s underwriting practices when guaranteeing riskier loans, suggesting curtailed activity in those areas.
The Treasury report says Fannie and Freddie should focus on their core mission of providing liquidity to the housing market and helping homeowners afford mortgages. Regulators are considering ordering the pair to stop competing with the private sector in some areas, such as cash-out refinancings or vacation home loans.
Reporting by Pete Schroeder; Editing by Tom Brown