Democratic Senators Urge Recapitalization Of Fannie Mae And Freddie Mac

Federal Home Loan Mortgage Corp FMCC and Federal National Mortgage Association FNMA shares caught fire Thursday, jumping more than 11 percent each after a new letter to Treasury Secretary Steven Mnuchin and Federal Housing Finance Agency director Mel Watt demonstrated that Congress hasn’t forgotten about Fannie Mae and Freddie Mac.

The letter, signed by senators Sherrod Brown (D-OH), Catherine Cortez Mastro (D-NV), Jack Reed (D-RI), Robert Menendez (D-NJ), Chris Van Hollen (D-MD) and Brain Schatz (D-HI), urges Mnuchin and Watt to address the fact that Fannie and Freddie aren’t retaining any capital on their balance sheets, potentially leaving them in need of another bailout during the next economic downturn.

Related Link: Fannie & Freddie Both Changed The Way They Talk About Their Dividends, And It's Not By Accident

“Specifically, we are concerned about the Department of Treasury and the Federal Housing Finance Agency’s (FHFA) requirement in the Preferred Stock Purchase Agreements (PSPAs) that the GSEs send all their income to the Treasury Department leaving two entities that back more than $5 trillion in mortgage debt with zero retained capital reserves beginning on January 1, 2018,” the letter reads.

Bailouts Part II

The senators are concerned that as soon as either of the GSEs start losing money, they will be forced to immediately draw from Treasury funds. By building up a sizable capital base, Fannie and Freddie could protect themselves from the next downturn.

While building up capital could potentially be a good first step in the right direction for Fannie and Freddie investors, the senators were clear that they aren’t calling for the GSEs to be released from government control.

“We are simply requesting that the GSEs be permitted to build capital. We do not believe they should be released from conservatorship absent reform.”

Democrats aren't the only ones calling for recapitalization, The Republican National Committee has said no American financial institution can operate safely without adequate capital and "taxpayers will not be sufficiently protected until Fannie Mae and Freddie Mac are permitted to rebuild equity capital."

A Long Road Ahead

Even if the government opts to begin recapitalizing the two GSEs, investors should keep their expectations in check. Earlier this year, Height Securities analyst Edwin Groshans estimates it would take roughly a decade for Fannie and Freddie to be adequately capitalized if they were allowed to retain 100 percent of their earnings.

The senators requested a response to the requests made in the letter by Sept. 29.

Mnuchin said Thursday plans for overhauling Fannie Mae and Freddie Mac won’t be addressed until next year, adding that he expects the companies to continue turning over their profits to the government.

“We need to fix Fannie and Freddie,” he said. “Realistically this is a 2018 issue, but we’re going to fix it and when we fix it we want to make sure we never put the taxpayers at risk.”

Related Link: Despite Courtroom Losing Streak, Legal Action Still Best Route For Fannie Mae, Freddie Mac Shareholders

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Image Credit: By The White House from Washington, DC (Regional Media Day: 7/25/17) [Public domain], via Wikimedia Commons