“We’ve got to get off the current boom-bust-bailout cycle, and I fear that with the status quo, it’s déjà vu all over again when it comes to Fannie and Freddie,” said Rep. Jeb Hensarling (R., Texas), chairman of the House Financial Services committee, in a statement. “It’s past time to put them on a wind-down path to prevent future taxpayer-funded bailouts.”, The Wall Street Journal

November 3, 2015, Joe Light, The Wall Street Journal

Markets

Freddie Mac Swings to Loss

Accounting adjustment puts mortgage-finance company in the red

Mortgage-finance company Freddie Mac said it swung to a loss in its third quarter.

Mortgage-finance company Freddie Mac said it swung to a loss in its third quarter. PHOTO: ANDREW HARRER/BLOOMBERG NEWS

By Joe Light

Freddie Mac on Tuesday posted its first quarterly loss in four years despite a healthy housing market, underscoring the challenges faced by the mortgage-finance giant in its eighth year of government control.

The McLean, Va., company reported a loss of $475 million for the third quarter, driven mainly by a quirk in accounting rules. Its $1.3 billion net worth means it doesn’t require a taxpayer bailout.

Still, the performance raises questions about Freddie’s long-term health. Over the past few years, rising home prices and lower mortgage defaults have bolstered the profits of Freddie and rival Fannie Mae.

Now, those benefits are receding, making the companies more susceptible to the need for taxpayer help should the housing market turn south and as the government requires them to wind down their capital reserves.

The loss comes as Freddie and competitor Fannie Mae remain caught between shareholders and civil-rights groups who want to see them freed from government control, a White House that believes the current system is broken, and a Congress that can’t come to agreement on what the future system should be.

“We’ve got to get off the current boom-bust-bailout cycle, and I fear that with the status quo, it’s déjà vu all over again when it comes to Fannie and Freddie,” said Rep. Jeb Hensarling (R., Texas), chairman of the House Financial Services committee, in a statement. “It’s past time to put them on a wind-down path to prevent future taxpayer-funded bailouts.”

The government took over Fannie and Freddie in 2008 and eventually infused them with $187.5 billion in bailout money. Since then, the companies have become highly profitable, paying out $239 billion in dividends.

Under the terms of the bailout agreement, Freddie and Fannie are required by 2018 to whittle their capital reserves to zero, meaning that even a minor hiccup in their businesses could force the need for a cash infusion from the U.S. Treasury. The companies combined still have $258 billion in available credit from the Treasury.

Under the current agreement with the Treasury Department, Fannie and Freddie are required to send nearly all of their profits to the government but aren’t required to pay a dividend when they post a loss.

Freddie’s third-quarter loss was driven mainly by an accounting discrepancy involving derivatives the company uses to protect against interest-rate changes. The derivatives are recorded at market value even though some of the hedged assets aren’t, resulting in a discrepancy that Freddie said caused a $1.5 billion hit to earnings.

Freddie Mac CEO Donald Layton said Freddie could change its methods for hedging interest-rate risk in the future to avoid an accounting-driven bailout.

“The decline of the capital reserve to zero creates real risk of our needing a draw. At the very least this risk is significant if we enter a recession and home prices commensurately decline,” Mr. Layton said on a call with reporters.

Mr. Layton said Freddie’s core business—of buying, securitizing and guaranteeing mortgages—remained strong. Freddie said its quarterly net interest income, which includes the fees it collects from backing mortgages, was $3.7 billion, down from nearly $4 billion in the second quarter and about the same as in the third quarter of 2014.

The housing market is on track for its strongest year since 2007. With rising home prices, fewer borrowers default on their mortgages, helping Freddie’s profitability.

But the loss is likely to renew calls for housing-finance reform from its proponents and for a change to the companies’ bailout terms from the companies’ shareholders.

“The prospect of any material losses by the [Fannie and Freddie] is another reminder that comprehensive housing finance reform is necessary,” said a Treasury Department spokesman in a statement. “Taxpayers remain on the hook for losses incurred by the GSEs, whether through the capital buffer or the ongoing, $258 billion backstop.”

The loss “indicates that it is just a matter of when, not if, a draw from Treasury is needed,” said David Stevens, president of the Mortgage Bankers Association, an industry group. “This is why thoughtful [Fannie and Freddie] reform is needed in order to minimize disruption to consumers and avoid adverse impacts to the housing finance system.”

Legislative efforts to replace Fannie and Freddie have mostly stalled since last year, and few observers believe significant housing legislation will pass in this Congress.

In the absence of legislation, a growing number of shareholders and civil-rights advocates have called for the administration to allow Fannie and Freddie to retain capital. Treasury Sec. Jacob Lew and other White House officials dismissed those calls last month, but as time goes on, some lawmakers who want to see the companies eliminated have said they fear they’re instead becoming more cemented in the housing-finance system.

Posted on November 4, 2015, in Postings. Bookmark the permalink. Leave a comment.

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