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Stress Test Predicts GSE Bailout in Worst-Case Scenario

DSN-freddiefannie-620x330Worst-case scenario: In the event of repeat of the 2008 economic downturn, the federal government’s main mortgage buyers, Fannie Mae and Freddie Mac may need another $190 billion bailout to keep them solvent. So say the results of the inaugural Dodd-Frank Act Stress Test, released by the Federal Housing Finance Agency Wednesday.

The stress test, known as DFAST, is a requirement under Dodd-Frank for financial agencies with $10 billion or more in consolidated assets that are overseen by a primary federal regulatory agency to project their financial health in the event of an economic crisis. And while such projections of major bailouts are merely what-ifs for the moment, the results of the stress test do paint a sobering picture of the economic wherewithal of Fannie and Freddie.

According to the results, a replay of the 2008 mortgage crisis would, at worst, be a near dollar-for-dollar replay of the $188 billion worth of federal funds Fannie and Freddie have received since the federal government took over both mortgage buyers that year.  However, under Fannie and Freddie’s best-case scenario, both entities would need a considerably smaller (though still hefty) hand, to the tune of $84.4 billion, according to the report.

Fannie and Freddie have returned nearly $203 billion in dividends after posting record profits, but since the government takeover, the companies are barred from keeping most of their earnings. In other words, they are not permitted to retain enough capital to withstand a sudden, unexpected economic shock. Earnings are sent to the Department of Treasury as the companies' way to pay down the bailouts from six years ago.

Kelli Parsons, a senior vice president at Fannie Mae, said in a statement Wednesday that under the senior preferred stock purchase agreement (SPSPA), the company's ability to accumulate capital is severely restricted and the company is required to reduce its capital on a yearly basis. As of December 31, Fannie’s remaining funding commitment under the SPSPA was $117.1 billion. Freddie’s outstanding balance was $72.3 billion, according to the company's April report.

According to Parsons, the conclusions of the stress test are not surprising, but she points out (as, in all fairness, does FHFA in its report) that these worst-case scenarios are not expected to actually happen. The range of possibilities is simply to show where the borders are.

Based on the worst-case, however—called a "severely adverse scenario" in the report—in which a sudden shock creates a deep recession, Fannie would require incremental draws of $34.4 billion from Treasury.  According to Parsons, if the company were required to make a one-time accounting adjustment relating to its deferred tax assets, Fannie would draw $97.2 billion, depending on the accounting treatment of deferred tax assets. This would leave the remaining funding commitment under the SPSPA at $83.1 billion, if a valuation allowance against deferred tax assets was not re-established. If Fannie could re-established a valuation allowance against deferred tax assets, the remaining funding commitment would be $20.4 billion, she said.

Parsons also said Fannie Mae, in conjunction with FHFA, has "developed forward looking financial projections" across three possible FHFA scenarios that would not require the company to draw from Treasury.

About Author: Scott_Morgan

Scott Morgan is a multi-award-winning journalist and editor based out of Texas. During his 11 years as a newspaper journalist, he wrote more than 4,000 published pieces. He's been recognized for his work since 2001, and his creative writing continues to win acclaim from readers and fellow writers alike. He is also a creative writing teacher and the author of several books, from short fiction to written works about writing.
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