FHFA To Force Financial Health Picture From Fannie Mae And Freddie Mac

Includes: FMCC, FNMA
by: Tom Dorsey

I have written several articles on this topic and there are two groups of investors watching Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC). The first group own shares and wants the government to release the GSEs back to the stockholders, so they, as stockholders can get their share of the billions of dollars of profit. The second group is outsiders watching, looking for the right time to buy in if the government releases the GSEs. Our assessment has not changed, and even solidified in our recommendation to sell both GSEs and invest in more financially rewarding investments at this time.

The financial mortgage market in the U.S. is about $10 trillion dollars. Fannie Mae and Freddie Mac play an important role that no company or group of companies can accomplish, which is maintaining the liquidity in the market. Fannie and Freddie buy mortgages from lenders and package them into securities on which they guarantee principal and interest payments.

The Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, ordered the companies in April 2012 to start writing off all loans delinquent that exceeded 180 days, which is the standard practice for regulated financial institutions. Fannie and Freddie previously did not charged off all the loans in this category. New regulations will require Fannie Mae and Freddie Mac to begin providing quarterly estimates of the financial impact of the accounting change that include all the delinquent loans to the FHFA. The FHFA gave the companies until January 2015 to comply. This delay in reporting will only increase speculation, hinder the truth about Fannie and Freddie's financial health and delay the planning and steps forward to reconcile all the bad loans.

The Federal Housing Finance Agency has initially reported that Fannie and Freddie have delinquent loans totaling in the billions. An early estimate of the total cost for the write-offs could top a trillion dollars. If 10% of the mortgage market would be written off for delinquent loans, the effects would be felt throughout the financial markets as well as the U.S. economy.

Two reasons why the Feds are moving slow on writing off these loans. First, it would cut into the profits the GSEs are posting each quarter, and that would reduce the amount of profits the federal government sweeps into the U.S. Treasury. The federal government benefits from the large quarterly deposits that are delaying the next round of the debt ceiling fight in Washington. Second, if the GSEs write off this large amount it would have a negative effect on the housing market. The housing market is a strong fundamental helping support the economy at this time. A drop of this magnitude in the housing market could flat line the economy for the rest of 2013 and into 2014.

The federal government is not going to allow Fannie and Freddie to become public again as President Barrack Obama has called for the firms to be wound down and replaced by a government reinsurer that would cover mortgage losses in catastrophic circumstances. Private capital would take the initial losses. Congress is also working on legislation that would liquidate Fannie and Freddie. In the Senate, Tennessee Republican Bob Corker and Virginia Democrat Mark Warner introduced a bill to close the agencies. Although the timeline and process is going to be shaped in the future, the intent is clear to shutter the doors to these agencies.

The two companies received $187.5 billion in taxpayer aid since 2008. Fannie and Freddie have sent the U.S. Treasury dividends totaling $132 billion, including $76 billion this year alone. Those payments count as a return on the government's investment, not as a repayment of the aid. Congress passed a bill with the President's signature that all profits from the two GSEs are considered dividends and not any repayment of the loans.

Fannie and Freddie will never repay the government loans unless the courts step in to force the issue. At that time Fannie and Freddie would still owe the government the $187.5 billion with interest/dividends during the repayment period. The government would then force the GSEs to retain the delinquent loans if they returned to the public sector and would be forced to burden the write offs then.

This is a no win solution for the investors of Fannie Mae and Freddie Mac. The bad news includes the time line of the court process is too long, the government's desire to wind down both Fannie and Freddie and replace it with another government agency and the bad loans that will have to be written off at some point in time. There will be no value in shares of either Fannie Mae or Freddie Mac.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.