Summary

Treasury gave the GSEs a blank check for Christmas. Clients will recall that, throughout the year, we have advised that the $400 billion backstop put in place by the Bush and Obama Administrations wouldn’t be enough, especially in light of the FASB consolidation rules. Treasury’s release makes clear that these are among the major reasons a new, unlimited commitment was provided. With it, the GSEs are insulated from any receivership Treasury doesn’t initiate to restructure them, allowing the GSEs to play any role Treasury demands in the mortgage market and the economy more generally. Clients will recall that the GSEs’ charters bind them only with regard to the mortgages they purchase, not non-mortgage loans they can make or other activities in which they may engage. 

Impact

Our analysis of key provisions in Treasury’s new agreement is as follows: 

  • There is no limit on how much Treasury will commit to Fannie and Freddie over the next three years, despite background briefings in which Treasury says it doesn’t expect to spend more than $175 billion. We think this number is low due to the FASB consolidation rules – recall that about $3 trillion goes on the books as of now, creating a very deep net-worth hole into which Treasury has now pledged to commit as much taxpayer dollars as necessary.
  • Fannie and Freddie will pay nothing for any of the $111 billion drawn down from Treasury to date and they could pay very, very little for any funding to come. The agreement revises the very steep dividend that would otherwise have kicked in next year, absolving the GSEs of any obligation related to funds received to date and making any new dividend unspecified and ineffective until 2011 or any other date Treasury accepts.
  • The GSEs can bulk up a bit. Again, Treasury will provide whatever support is necessary to keep the GSEs above negative net worth. The initial $900 billion limit remains, but it can be gradually reduced going forward instead of sharply cut as initially required. This makes Fannie and Freddie a handy place to put whatever assets Treasury may want them to hold, as well as ensuring that the GSEs can continue to absorb mortgage purchases even if the FRB, as anticipated, stops buying MBS after March 31, 2010.

In essence, this is a conservatorship not for common shareholders – the usualunderstanding of the concept – but rather for public-policy purposes. Treasury and FHFA have agreed to support whatever activities they demand of the GSEs, as well as ensure that no accounting rule, credit loss or other untoward event challenges the GSEs’ ongoing ability to do what they are told. Because Treasury’s commitment stands regardless of the GSEs’ status – even including receivership or bankruptcy – nothing stays the Administration’s hand in turning them into anything it wants. 

Outlook

So, what might that be? In its statement, Treasury has delayed the Administration GSE plan the President promised would accompany the FY11 budget. Now, we are told only a “preliminary” plan will come “around the time” of the budget. So, for now, the GSEs are what they are – whatever that is. Will Congress let this stand? We think so. Sen. Shelby almost surely knew of thisagreement when he signed a joint statement last week with Sen. Dodd omitting GSE reform from the Senate Banking to-do list. Of course, he can’t speak for other GOP Members in both Houses who want GSE reform now, but he is in the driver’s seat as to whether they get it. Treasury has made inaction now a bit easier by failing to put a total on its GSE backstop. Had it put a number — say $1 trillion — on the table, deficit hawks of all feather would have flocked to decry the support. Without a number, they can squawk, but it’s harder to size Treasury’s commitment and – most important – put it in play when the debt ceiling comes up next month for tough going over. In our next analysis, we’ll consider the impact Treasury’s action has on the shape of GSEs to come.

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