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Moody’s: Privatizing Fannie Mae, Freddie Mac would cost “hundreds of billions”

Report predicts disruption to secondary market

Long an idea left idling amid Congressional wrangling and governmental malaise, releasing Fannie Mae and Freddie Mac from conservatorship became a distinct and real possibility recently when Steve Mnuchin, President-elect Donald Trump’s choice to lead the Department of the Treasury, said that “getting Fannie and Freddie out of government ownership” is one of the Trump administration’s top 10 priorities.

Mnuchin’s proclamation sent the stocks of Fannie and Freddie soaring to heights not seen in two years, as investors bet that Mnuchin’s words would soon become a reality.

But just how realistic is privatizing Fannie and Freddie, in whatever form the Trump administration plans? And what will it take to get there?

According to a new report from Moody’s Investors Service, privatizing the GSEs is not only unlikely to happen any time soon, it’s also hugely cost-prohibitive, and it would be a negative for bond investors as well.

Other than that, Mrs. Lincoln, how was the show?

As Moody’s notes, the capital buffers of each Fannie and Freddie are set to be drawn down over the next few years, from $1.2 billion in 2016, down to $600 million in 2017, and eventually to $0 in 2018.

That drawdown is part of the government’s preferred stock purchase agreement with the GSEs, which allows for the GSEs to take an additional draw from the Treasury if needed, but also sends all of the enterprises’ profits to the Treasury.

But for the enterprises to be removed from their current state of conservatorship, each of the GSEs would need a massive capital buffer to ensure the continued fluidity of the mortgage market.

If the GSEs were to continue to support the mortgage market as they do today, in order for privatization to work, each would need a strong capital base that likely totals in the “hundreds of billions of dollars,” Moody’s says in its report.

One of the issues with rebuilding that capital base is the amount of debt that each of the GSEs holds.

“Privatization would be credit negative for the GSEs because it increases the risk of funding disruptions owing to the many questions about how privatization would occur given the amount of debt the GSEs must refinance,” Moody’s analyst Brian Harris writes in the report.” And, confidence in (the GSEs’) financial standing would be critical given the need to refinance their debts during any transition to becoming a private company.”

According to the Moody’s report, Fannie Mae’s outstanding debt totaled $351.6 billion as of third quarter of 2016, while Freddie Mac’s was $378.1 billion.

Additionally, Fannie Mae had $51.4 billion of discount notes outstanding as of the end of the third quarter of 2016, while Freddie Mac had $69.3 billion outstanding during the same time period.

The GSEs also have $4.6 trillion of mortgage-backed securities outstanding, which is close to 25% of the nation’s gross domestic product.

“Disruptions in their ability to issue debt, materially higher debt issuing costs or a decline in mortgage-backed securities pricing would negatively affect US housing and the US economy,” Harris writes.

“Although GSE reform could take many directions, we believe the likely path will include government support for the senior debt issued by the companies before the implementation of reform through final maturity, and expect the effective substitution of the US sovereign rating for these obligations to continue,” Harris writes. “Nevertheless, there are alternative reform outcomes that would be less creditor friendly, as well as many variables that could change the path of reform, making the ultimate outcome highly uncertain.”

Also a consideration is the likely reluctance of Federal Housing Finance Agency Director Mel Watt to support ending conservatorship.

“Mr. Watt has given no indication that he believes the GSEs are healthy enough to end conservatorship. Plus, it is unclear how affordable housing mandates would work under privatized GSEs,” Harris writes. “Mr. Watt’s five-year term as FHFA director is not subject to affirmation by the incoming administration and runs through 2019, which would allow him to slow down any privatization effort.”

Given all of those factors, Harris suggests that GSE reform isn’t likely to take place in the first year of Trump’s term and perhaps even beyond that.

“Although we recognize this overall uncertainty, we also believe that any change in the GSEs’ current setup is unlikely to occur during our rating outlook horizon of the next 12-18 months, and thus we have a stable rating outlook,” Harris writes. “Despite Mr. Mnuchin’s comments, we believe that there is a very low probability that the GSEs will be privatized over the next few years given their capital needs and complexities of privatization.”

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