The Treasury Department directed Fannie Mae and Freddie Mac to come up with a plan to replace their quarterly dividend payment with all profits going forward.
The government-sponsored enterprises can only pay a 10% quarterly dividend on the preferred stock the government owns, according to its conservatorship agreements. As they begin to earn profits again, a Fannie Mae executive said they are forced to sweep the excess cash into a future fund. The limit on how much the GSEs can pay back from their profits makes it difficult to ever return the $188 billion both firms received from taxpayers, especially if they report losses again and require further draws.
Treasury said Friday the new plan to be developed with the Federal Housing Finance Agency will ensure "every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms."
After this year, Treasury will cap its remaining support for Fannie at approximately $125 billion and its support for Freddie would be roughly $150 billion.
Should housing turn down again, the GSEs may burn through the capital limits and default on its bond payments. Jaret Seiberg, a policy analyst at Guggenheim Partners in D.C. said just the fear of this could drive up their borrowing costs and force them to seek taxpayer dollars more quickly.
"This creates a vicious cycle that Treasury wanted to keep from starting," Seiberg said.
The government will also speed up the reduction of the GSE investment portfolio to a 15% annual reduction from the previous 10% in cuts. Their portfolios must now be reduced to the $250 billion target four years earlier than the 12 years previously estimated.
As of June, the Fannie portfolio stood at $672 billion and Freddie held a $581 billion portfolio, according to their monthly summary reports.
"With today's announcement, we are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac, while continuing to support the necessary process of repair and recovery in the housing market," said Michael Stegman, counselor to the Secretary of the Treasury for housing finance policy. "As we continue to work toward bi-partisan housing finance reform, we are committed to putting in place measures right now that support continued access to mortgage credit for American families, promote a responsible transition, and protect taxpayer interests."
FHFA Acting Director Edward DeMarco said the move with the Treasury will ease the market's concern. The accelerated reduction to the portfolios will also trim future risk.
"Replacing the current fixed dividend in the (preferred stock purchase agreements) with a variable dividend based on net worth will help to ensure stability, fully capture financial benefits for taxpayers, and eliminate the need for Fannie Mae and Freddie Mac to continue to borrow from the Treasury Department to pay dividends," DeMarco said.
Since the Treasury detailed three options in February 2011, no bill in Congress to replace the GSEs or establish a new housing finance system has made it out of a committee in either the House or Senate.