In the months before Donald Trump entered the White House the first time around, speculation mounted that he would release mortgage giants Fannie Mae and Freddie Mac from the federal conservatorship they’d operated under since being bailed out during the global financial crisis. “We got to get Fannie and Freddie out of government ownership,” Steven Mnuchin, Trump’s pick for Treasury Secretary, said. “It makes no sense that these are owned by the government and have been controlled by the government for as long as they have.”
Trump came and went – and nothing happened. The companies had insufficient capital to survive on their own, and Trump had a hard time dislodging the head of the agency that oversaw them. Then a pandemic got in the way. Eight years later, Fannie and Freddie remain in government hands.
Now, he has another chance, and some investors are getting excited. Shares in the pair – traded over-the-counter on so-called pink sheets – have surged almost 150% since the election, and multiple series of their preferred stock have also surged. Long-term holders such as Bill Ackman, a vocal Trump supporter, have reaped windfall profits.
While a release from conservatorship would be welcome, many issues still need to be resolved. First, policymakers at the Treasury Department and the Federal Housing Finance Agency (FHFA) need to align on the goal. Some may argue that the mortgage system works fine and should be left alone. Between them, Fannie and Freddie provided $219 billion of liquidity to the housing market in the third quarter, financing almost 800,000 homes. Meddling with their corporate structure risks upsetting market dynamics.
But Trump sees a bigger prize. Conservatorship was never meant to be permanent, and resolving it would allow him to do something his predecessors couldn’t, while also crystallizing gains. Always the dealmaker, he wrote after leaving office in 2021 that absent any constraints, “my Administration would have also sold the government’s common stock in these companies at a huge profit and fully privatized the companies.”
If privatization is the objective, the next question is how much capital Fannie and Freddie would need to retain to operate as public companies. Under a regulatory capital framework unveiled in the dying days of the Trump administration, the companies’ aggregate capital requirement is $281 billion, equivalent to around 12% of risk-weighted assets – similar to what banks are required to hold.
But that seems harsh. Stress tests conducted by the FHFA suggest much less would be sufficient to withstand adverse shocks. Based on FHFA modeling, Fannie and Freddie would still make money even in an environment where house prices decline 38% and unemployment hits 10%. Any credit losses that ensue would be more than mopped up by income.
Still, a high capital threshold provides comfort, and if they are to be returned to the market, nobody wants them in a position where they need to be bailed out again.
Once a capital requirement has been determined, the question facing Treasury is how much value to extract. The government currently has two claims on Fannie and Freddie: a senior preferred claim relating to $191 billion of capital pumped in to stabilize the pair in the aftermath of the 2008 crisis; and warrants over 79.9% of common stock – which expire in September 2028, creating some urgency to proceedings.
As compensation for the former, Treasury has already taken out $301 billion in cash dividends, an impressive return that European bailout funds will envyDividends were turned off in 2019 to allow the companies to rebuild capital, but in lieu, Treasury added to the liquidation preference on its senior preferred stock, increasing it by $150 billion to date. Officials could insist on repayment of principal, but that would blow a hole in the companies’ balance sheets. Rather, they could seek to maximize the value of their warrants by eliminating their outstanding senior preferred claim or converting it to equity.
In such a scenario, Fannie and Freddie would be left with $147 billion of available capital. That includes $33 billion of junior preferred stock held by outside investors such as Ackman’s Pershing Square, which could be exchanged for common stock to improve the quality of the overall capital base, as Citigroup Inc. did in 2009. There would still be a capital shortfall, but with the companies generating around $28 billion a year of net income, it would be closed quickly. A public share offering could fill any remaining gap.
So how much could the government take out? The range of options open to Treasury to extract value makes it a tricky question, and that’s before we consider the politics. Fannie and Freddie have always been highly politicized entities, even before the conservatorship, given their private structure and public mandate to foster efficient national housing finance markets that support sustainable ownership and affordable rentals. But if the companies’ earnings can be sustained and they attract a multiple of 10 times, then a valuation of $280 billion could be realistic. Securing the lion’s share of that for taxpayers would give Trump something to boast about: the biggest IPO ever.
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