Mnuchin dashes investor dreams of quick Fannie-Freddie windfall

Washington

US Treasury Secretary Steven Mnuchin made it clear that freeing Fannie Mae and Freddie Mac from US control won't happen without a major overhaul of the nation's housing finance system, potentially dashing investors' hopes that they might soon make a windfall from their stakes in the mortgage giants.

In a June 8 interview, Mr Mnuchin was adamant that the Trump administration won't just let Fannie and Freddie build up their capital buffers and then release the companies. He also said he backed a key reform that can only be implemented by Congress, casting doubt on how ambitious the administration will be absent a legislative fix.

"What we're not going to do is business as usual with no changes, just re-capitalise them and float them," said Mr Mnuchin, referring to a possible public offering of Fannie and Freddie shares. "There needs to be housing reform as part of this."

The comments would seem to push back a process known as recap and release, which would consist of bolstering Fannie and Freddie's ability to absorb losses and then returning them to exclusively private shareholder ownership.

Hedge funds have long seen a quick recap and release as the fastest and simplest way to mint fortunes off their investments in the companies, partly because it can be done without the involvement of lawmakers.

Mr Mnuchin's remarks also underscore that despite the administration's determination, solving the biggest outstanding issue from the 2008 financial crisis is easier said than done.

The companies were seized by regulators and bailed out by taxpayers during the housing market collapse, ultimately getting US$191.5 billion in aid. They have returned to profitability and returned to the government more in dividend payments than they got in bailout funds.

US President Donald Trump has ordered the Treasury Department to come up with a proposal for ending the Fannie and Freddie conservatorships, and that plan could be released within weeks, people familiar with the matter have said. While Fannie and Freddie don't make loans, they are crucial to keeping the nation's housing-finance system humming.

That's because they buy mortgages from lenders and package the debt into bonds that are sold to investors with guarantees of interest and principal. The process makes homes more affordable, while keeping the mortgage market liquid.

Mr Mnuchin, during the interview along the sidelines of a finance ministers' summit in Japan, added that he would prefer an explicit government backstop of Fannie and Freddie securities. That would make the debt incredibly safe in the minds of bond investors, even if the two companies were released from conservatorship.

While many housing-finance policy changes can be made administratively, an explicit US guarantee can only be created by Congress.

Federal Housing Finance Agency (FHFA) director Mark Calabria, Fannie and Freddie's independent regulator, has said that such a guarantee is not a prerequisite for the companies to be freed.

But Treasury and the FHFA would have to agree on major parts of any plan that releases the companies without the involvement of lawmakers. "It is as if Mnuchin is the good cop and Calabria is the bad cop," said Ed Mills, policy analyst at Raymond James & Associates Inc. "It's clearly preferable to have a legislative solution with an explicit guarantee as it relates to limiting any disruption to the housing system. However, it is unclear if Congress is going to act unless they are pressured into feeling that they will have executive action without them."

Lawmakers have failed for more than a decade to agree to an overhaul of Fannie and Freddie. While they are now making a renewed push, reaching a deal seems challenging considering the level of congressional partisanship.

One of the biggest questions about Fannie and Freddie's potential exit from conservatorship is how they would raise enough capital to withstand a financial calamity, which both Mr Mnuchin and Mr Calabria have said is a precondition to the companies being released. Regulators have indicated that the amount they'd need might exceed US$200 billion. Right now, each company is restricted to a capital cushion of US$3 billion.

While Mr Calabria has said he thinks a public offering of Fannie and Freddie shares will likely be necessary, Mr Mnuchin suggested in the interview that private money could also be used. "Could be IPO, could be private capital, there are lots of ways of doing it, but ultimately it would need a combination of retention and capital raise," he noted.

A stock sale would not only likely be the largest in history, but also one of the most complex, considering the conservatorships and because Treasury owns nearly 80 per cent of Fannie and Freddie's senior preferred shares.

Raymond James' Mr Mills said such an offering would likely be at least three to four years away, because of all the steps involved. BLOOMBERG