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Updated Cost of Fannie and Freddie Bailout

Anthony Randazzo
October 25, 2010, 7:56am

Barney Frank is fond of pointing out that the losses being experienced by Fannie and Freddie aren't because of their current activities, and in a way this isn't totally off. The $148.3 billion Treasury has given from taxpayer coffers to the GSEs has been to cover losses on mortgage deals made from the bubble period. I.e. today's defaults are on yesterdays mortgages. And losses from yesterdays mortgages are continuing to mount on default and foreclosure problems.

But today's defaults and foreclosure problems are made worse by the administration's housing policies today. Whether the Making Home Affordable programs like HAMP (to modify mortgages) or the First-time Homebuyers Tax Credit, the actions of the White House and Congress can affect the losses at Fannie and Freddie. So while the GSEs activities today are not directly creating their current losses, their participation in an administration while effort—from HUD to Treasury—to "fix" the housing market is impacting their losses.

Given mostly universal acceptance that HAMP has been a failure, and the general agreement that the tax credit didn't create any sustainable growth, it is fair to say the government has made the default problem—and by extension the GSE problem—worse. And what the government does in the future will determine just how high the losses get.

This is also the finding of a recent report from the Federal Housing Finance Authority (FHFA), who has suggested the remaining losses for Fannie and Freddie could be anywhere between another $124 billion and $6 billion (including dividend payments), depending on the housing market over the next three years. Here is an explanation from The New York Times:

"In coming up with the latest aid projections, the housing finance agency performed three sets of stress tests on the companies, each reflecting a different set of assumptions about the economy.

In the bleakest case, the economy would return to recession and housing prices would tumble again, falling 45 percent in total from the peak levels of 2006. The companies might then require another $215 billion from Treasury, of which they would return $91 billion in the form of dividend payments. The total cost to taxpayers: $259 billion, including the $135 billion already spent, or new assistance of $124 billion.

In the most optimistic case, housing prices would hit bottom this fall, about 31 percent below the 2006 peak, and then begin to recover as the economy continues to grow. The companies might then require another $73 billion in aid, of which they would return $67 billion in dividend payments. The total cost to taxpayers: $141 billion, only slightly more than the $135 billion that has already been spent.

The agency says that it considers the third, intermediate case to be the most likely. Housing prices would continue to decline until next fall, bottoming out 34 percent below 2006 prices, and then begin a slow recovery. Fannie and Freddie might then require about $90 billion in aid, of which they would return $71 billion in dividend payments. The total cost to taxpayers would be $19 billion on top of the $135 billion already provided, or a total of $154 billion."

Note, that the $135 billion cost listed above is after $13 billion in dividend payments from Fannie and Freddie. Though the whole concept of paying out dividends right now to Treasury because of the conservatorship—and then asking for at least that amount down the road in loans from Treasury is a really odd concept.

In any case, the reality is that there are more losses on the horizon for Fannie and Freddie that will be paid for by the taxpayers because the Obama administration failed to deal with the GSE problem in its first two years on a fear that it would destabilize the housing market. To be fair, increased price losses do have the potential to create more default problems with more underwater individuals stopping their mortgage payments. And ending the conservatorship in the past two years would have negatively impacted prices. But a drop in prices don't necessarily mean there will be more losses.

If people are underwater they might stop paying their mortgages, but not necessarily. It is more likely that increased unemployment problems would leading to more defaults, meaning worse losses for the GSEs. And as GMU professor Anthony Sanders told Financial Times: “It’s unlikely the housing market will come roaring back.”

If the administration wants to prevent a worst case scenario, the plan shouldn't be continuing to manipulate the housing market. Focusing on encouraging more investment in the US leading to job creation would be a much better approach—i.e., favoring a stronger dollar policy (instead of QE2 as we're likely to see) to encourage foreign investment, avoiding tax increases or talk of increasing taxes so that businesses don't hold on to cash in fear, and restraining oppressive regulation on financial services.

As a final note, CBO has suggested that "Fannie and Freddie would need $390bn in federal subsidies [by] the end of 2019. The White House’s Office of Management and Budget had in February estimated the cost to be as little as $160bn for the same period, providing the economy continued to strengthen.


Anthony Randazzo is Director of Economic Research


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