Could Debt Worries Accelerate Fannie, Freddie Overhaul?

The Wall Street Journal

Most Washington pundits don’t expect any major political action on mortgage giants Fannie Mae and Freddie Mac before the 2012 election, but growing jitters over the nation’s debt illustrate one potential catalyst that could keep the current conservatorship of the firms from dragging on indefinitely.

On Monday, Standard & Poor’s placed the U.S. AAA-rating on negative outlook. It cited the potential cost of the U.S. government’s conservatorship of the mortgage-finance giants in tilting the scales in its decision.  Here’s what S&P said:

We estimate that it could cost the U.S. government as much as 3.5% of GDP to appropriately capitalize and relaunch Fannie Mae and Freddie Mac, two financial institutions now under federal control, in addition to the 1% of GDP already invested.

And in a question-and-answer brief:

Do the finances of the U.S. government-supported enterprises (GSEs) affect the U.S. sovereign rating? Yes. We estimate that the government might have to inject up to $280 billion to cover losses at Fannie Mae and Freddie Mac; this includes $148 billion already spent. (Both GSEs are already in conservatorship.) Moreover, by our estimates, that $280 billion could swell to $685 billion if the government capitalizes Fannie and Freddie on a commercial basis.

Some analysts may take issue with those loss projections. Others will note that the U.S. will try to attract private, not public, funds to recapitalize any successors to Fannie and Freddie. Margaret Kerins, an analyst at Royal Bank of Scotland, writes in a research note Monday that such an outcome is “highly unlikely.”

The government has so far avoided bringing Fannie and Freddie onto the government’s books because that would boost the federal deficit by tens of billions and it could swell the total debt of the U.S. (Recall that Fannie Mae was privatized in 1968 when the Johnson administration was trying to reduce the country’s debt.)

The Bush administration cited the “temporary nature” of the government’s stewardship of Fannie and Freddie in opting not to incorporate those obligations back onto the government’s books.

There are plenty of reasons why the political establishment has been slow to act on Fannie and Freddie: The housing market is fragile and possibly unable to digest major changes right now. No one likes the current arrangement, but it does appear to be working (how else to explain mortgage rates that have spent the last 18 months below 5%). And any political solution on Fannie and Freddie will have to forge consensus between conservatives and liberals who publicly remain very far apart about what housing-finance should look like.

But for anyone wondering, what, if anything, will accelerate the timetable for untangling Fannie, Freddie, and Uncle Sam, the debt picture certainly serves as one plausible catalyst.

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