You’re looking at an excerpt from the 2008 Housing and Economic Recovery Act. That’s the thing which created the Federal Housing Finance Agency (FHFA), which is currently charged with regulating the US’s massive Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac.
We bring it up because there’s an interesting — even conspiratorial – note concerning the fate of the GSEs in the face of the US debt ceiling debate, from Bank of America Merrill Lynch’s Ralph Axel.
First though, some quick background.
In addition to establishing the FHFA, the Act also sets out the conditions under which the agency can take receivership or conservatorship of the two mortgage giants. The difference between the two states of GSE being, so to speak, are important. In conservatorship, the FHFA is basically conserving the assets of the GSEs and running them pretty much as normal. In receivership, the FHFA would wind the GSEs down by selling off their assets to pay creditors, raising the possibility of losses for investors.
And that’s where that little HERA excerpt comes in.
Whenever the GSEs report a capital shortfall (not a remote possibility, given that the two enterprises have chalked up billions of losses since the bursting of the housing bubble, and have to make preferred stock payments too) the FHFA has to ask the US Treasury for money to plug the gap. The Treasury then has to send the funds to the GSE within 60 days. Enter the US debt ceiling dispute, which could see the US suspend payments from August if Democrats and Republicans don’t reach agreement.
If the US is not able to make a necessary payment to the GSEs within that 60-day period, then the HERA clause comes into play. And suddenly the GSEs could switch from being in conservatorship to receivership. The FHFA would have about five years to liquidate the assets (Fannie Mae has about $3,200bn and Freddie has $2,200bn!) but the face of US mortgage finance would be forever changed.
Not that some people haven’t been angling for this already. Republicans, in particular, have been arguing that winding down the US government’s support for the GSEs is the best thing for taxpayers.
All of which leads BofAML’s Axel to conclude:
Ending the government bailout of the GSEs has been one of the major battle calls of the Republican party for several years, and they will not be unfamiliar with the terms of HERA 2008. It may be going too far to suggest that the surprising delays in reaching a debt ceiling agreement relate to their desire to wind down the GSEs, but at this point we can not rule it out.
The receivership possibility is an extreme tail risk given that the US could still prioritise payments to the GSEs, come the August deadline. But it’s still a risk that has not gone unnoticed by markets.
RBS’s Margaret Kerins also wrote a whole note discussing the (remote) possibility.
And setting aside receivership risk, there are other ways the debt ceiling could impact the GSEs too, most notably with respect to their ratings. Moody’s has already said both Fannie and Freddie’s ratings are at risk should the US be downgraded, given their current inclusion of government support.
So even if the debt ceiling drama isn’t all about GSEs, they won’t avoid its chaotic effects.
Related links:
All the devils are here - Google books
Will Treasury abandon the GSEs? - RBS
A ‘disastrous’ Republican proposal to redo Fannie and Freddie - Annie Lowrey, 2010