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Why Is the U.S. Downplaying Huge Profits at Fannie, Freddie?

blogs.wsj.com | January 26, 2014

By Nick Timiraos

No biggie.

That’s the reaction a top Treasury Department adviser took Wednesday to the record profits hauled in by Fannie MaeFNMA -3.54% and Freddie MacFMCC -2.66% over the past year.

The government-supported mortgage-finance giants have reported combined net income of $151 billion during the first three quarters of 2013, but Michael Stegman, the Treasury adviser, warned that those recent returns “may significantly overstate the true financial condition” the companies, “especially on a go-forward basis.”

Mr. Stegman, who spoke at an industry conference in Las Vegas, said that around $75 billion of the firms’ net income has come from one-time tax reversals, as the companies reversed huge write-downs they were forced to take in 2008, when the companies lost the ability to claim certain tax assets as losses mounted.

Another $11 billion in income, Mr. Stegman said, has come from releasing loan-loss reserves, and the companies have hauled in another $10 billion from one-time legal settlements with Wall Street banks over soured mortgages and related investments sold at the peak of the housing bubble.

What’s left after those gains are the core businesses of Fannie and Freddie: earning a return on loans held as investments in the companies’ large portfolios and collecting fees for insuring loans that are bundled into mortgage-backed securities before they are sold to investors.

The portfolio business, Mr. Stegman said, accounted for around 60% of the companies’ combined income, and those investment portfolios—currently a combined $1 trillion—are being wound down by 15% annually until 2018, when they will be capped at around $250 billion each.

Recent financials also have “benefited significantly from strong home-price appreciation and low interest rates, both of which may moderate in future periods,” he said.

Mr. Stegman didn’t say that he expected the companies to lose money, and a handful of analysts who still follow the companies expect the firms to derive healthy profits, still, from their loan-guarantee businesses.

So why would a top Obama administration official pooh-pooh record profits when, in other instances (say, with General Motors or American International Group Inc.AIG -2.74%) it might be touting such windfalls?

First, the Obama administration doesn’t want the profits to remove the urgency for Congress to decide how to overhaul Fannie and Freddie. Some stakeholders “mistakenly argue that housing finance reform is no longer needed — that the [companies] are so financially flush” to reduce the need for legislation, he said. “We could not disagree more.” The administration has made clear it doesn’t support returning Fannie and Freddie to their former duopoly status as “government-sponsored” entities that are neither fully private nor fully public.

The profits could not only remove the urgency for any overhaul, but they could also lead lawmakers to grow more comfortable with less dramatic changes whenever they get around to proposing such an overhaul. Mr. Stegman’s speech went into more detail about how any successors to Fannie and Freddie, for example, shouldn’t combine the roles of guaranteeing mortgages with issuing government-backed securities. In other words, unlike big banks and automakers that were bailed out by the government and largely restored to their previous private ownership, Fannie and Freddie aren’t going to be returned to their pre-2008 model if the Obama administration has anything to say about it.

Federal courts, meanwhile, are set to weigh in on how the company’s shareholders have to be treated in any such overhaul. The Treasury Department faces numerous legal challenges from shareholders who have argued that certain changes made in 2012 to the firms’ bailout agreements led the U.S. to illegally expropriate the companies’ assets. The Treasury filed briefs to dismiss some of those lawsuits last week, arguing that shareholders didn’t have standing to challenge the bailout changes.

 

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