Have Fannie and Freddie Paid the Taxpayers Back Yet?

Published in the Real Clear Markets.

The distinguished judges of the U.S. Court of Appeals for the Fifth Circuit have considered how much Fannie Mae and Freddie Mac have paid the Treasury Department to compensate the taxpayers for the giant bailout which kept Fannie and Freddie in existence and business.  The court observed in its September 6 judgment:

“The net worth sweep transferred a fortune from Fannie and Freddie to Treasury.”  Specifically, “Treasury had disbursed $187 billion and recouped $250 billion.”

The “net worth sweep” is the dividend on the senior preferred stock in Fannie and Freddie acquired by the Treasury in the bailout.  Originally set at 10% per year in 2008, the dividend was changed in August 2012—in the “Third Amendment” to the governing agreement—to essentially, “just send in all your profit” each quarter, hence a “sweep.”  The Treasury then owned $187 billion of senior preferred stock acquired for cash, as the court suggested, and another $2 billion in exchange for the original credit support agreement, for a total of $189 billion.  (Now it owns $199 billion.)

Fannie and Freddie should, said the court, “of course…pay back Treasury for [their] draws on the funding commitment.” And “Treasury was also entitled to compensation for the cost of financing.”  No one could disagree.  “But the net worth sweep continues transferring [Fannie and Freddie’s] net worth indefinitely, well after Treasury has been repaid,” it critically points out.  This must make us ask: Have Treasury and the taxpayers been repaid at this point?  The answer is not obvious, as sometimes has been asserted, and requires a little arithmetic.

In short, does having been paid $250 billion vs. a $189 billion principal amount automatically mean full repayment?  As every banker knows, it doesn’t.

Consider a simple analogy.  Suppose you borrowed $1,000 at an interest rate of 10%, under a $5,000 commitment with a commitment fee of 1% per year.  Suppose you pay only the interest and the commitment fee, but never a penny of principal.  After ten years, you will have paid $1,500.   You could truly observe that “You lent me $1,000 and I have paid you $1,500.”  But how much principal do you still owe?  You still owe all $1,000, without a doubt.

We can apply the same logic to Fannie and Freddie and see what happens.

Let us go back to August 2012, and suppose that the Third Amendment and the “net worth sweep” had never happened.  There is outstanding $189 billion of senior preferred stock.  The dividend remains the original 10%.  That is a dividend of $18.9 billion a year.  In addition to the dividend, as the court rightly noted, the original deal provides for Treasury also to charge an ongoing commitment fee. This was to compensate the taxpayers for their continuing credit support, which backed up and continues to back up all Fannie and Freddie’s liabilities.  Nine Fifth Circuit judges in an accompanying opinion call this support “a virtually unlimited line of credit from the Treasury.”  It effectively guarantees liabilities totaling $5.5 trillion—you don’t get that for free.  With vast liabilities and effectively zero capital, Fannie and Freddie could not function for even a minute without taxpayer support.  The Housing Reform Plan just published by the Treasury clearly provides for Fannie and Freddie to pay a commitment fee—and they undoubtedly should.

What would be a fair price for the taxpayers’ credit commitment?  Based on what the FDIC would charge a severely undercapitalized bank for the credit guarantee which is called deposit insurance, I believe 0.18% of total liabilities per year is a good guess.  This credit support fee on $5.5 trillion in liabilities gives an annual fee of $9.9 billion.

Thus, going back to our hypothetical 2012 with no profit sweep, Fannie and Freddie should have been paying Treasury $18.9 billion plus $9.9 billion or a total of $28.8 billion a year.  That was seven years ago.  Had Fannie and Freddie been paying that instead of the profit sweep for seven years the aggregate payment for dividends and commitment fee only, would have been $202 billion.  That payment would provide no reduction of the $189 billion of principal.

But Fannie and Freddie paid $250 billion.  That is $42 billion more than $202 billion, which might fairly be used to retire some of the $189 billion principal.  If we credit Fannie and Freddie with the going rate of interest, say 2%, on this amount, we might make that $45 billion.  That gives us $189 billion less $45 billion, leaving $144 billion of principal still to be repaid.

Suppose you think my suggested commitment fee is too high.  Let us cut it in half, to 0.09 %.  Then by analogous math, Fannie and Freddie’s required payment of 10% dividends plus commitment fees would be $23.9 billion a year, or $167 billion in total for seven years.  That would leave $83 billion, or $88 billion with interest, for principal reduction.  Result: they would have $101 billion still to pay.

Even when we remove by hypothesis Treasury’s claim on the perpetual net worth sweep criticized by the court, it is far from the case that Treasury has been repaid.

These considerations must be taken into account as Treasury and the Federal Housing Finance Agency (as conservator for Fannie and Freddie) revise the Preferred Stock Purchase Agreement as part of the administration’s housing finance reform plan.