A recent report from the Inspector General of the Federal Housing Finance Agency implicitly warned Congress that, in their current configuration, Fannie Mae and Freddie Mac could need major future U.S. taxpayer bailouts.
The report did not recommend Congress take up secondary mortgage market reform, but it detailed observations regarding how the two mortgage giants remain vulnerable as currently organized.
First, the report pointed out that under their conservatorship terms, Fannie and Freddie must reduce the size of their retained investment portfolios. These retained portfolios provided the bulk of GSE income in the past. By the end of 2008, Fannie and Freddie's combined retained stood at $1.6 trillion, but had fallen to roughly $822 million by the end of 2014, the IG reported.
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"The enterprises have cautioned that income growth from guarantee fees may not completely offset the loss in income from the retained portfolios," the IG wrote.
Second, Fannie and Freddie's core earnings – coming from single family mortgages, multifamily mortgages and investments – made up only 40% of their combined net income in 2013. The other 60% came from non-recurring tax related items and large legal settlements that are not likely to be repeated and cannot be considered sustainable, the IG reported.
Third, under the current terms of their conservatorships, Fannie and Freddie can't build a financial reserve to enable them to better handle balance sheet shocks such as an economic downturn or a sharp drop in real estate values.
Fourth, the FHFA stress tests published in April 2014 indicated that, under a worst case scenario, Fannie and Freddie would need to draw another $84 billion to $190 billion.
"Absent Congressional action, or a change in FHFA's current strategy, the conservatorships will go on indefinitely. The enterprises' future status is beyond their control. At present, it appears that Congressional action will be needed to define what role, if any, the enterprises play in the housing finance system," the IG wrote.
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