The Federal Housing Finance Agency published a report on Thursday, April 30th that notes that Fannie Mae and Freddie Mac might need as much as a $160 billion infusion from the U.S. Treasury in a worst case economic meltdown scenario. The report is titled “Dodd-Frank Act Stress Tests – Severely Adverse Scenario.”
Of note, the FHFA is the federal agency charged with regulating Fannie and Freddie.
“Severely adverse” circumstances
The new FHFA report focuses on the potential financial needs of Fannie Mae and Freddie Mac in “severely adverse” circumstances such as a four-percent jump in the unemployment rate to 10% by mid-2016, together with a major drop off in economic growth. In a severely adverse scenario, services for homes and other assets would drop dramatically, while market volatility would spike and spreads on U.S. investment-grade bonds would move up.
It is important to note that the FHFA does not anticipate such a severe scenario will come to pass. The report is for regulators to see how Fannie and Freddie would hold up under extreme stress for planning purposes.
The report notes: “The projections reported here are not expected outcomes. They are modeled projections in response to ‘what if’ exercises based on assumptions about [Fannie and Freddie’s] operations, loan performance, macroeconomic and financial market conditions, and house prices.”
Fannie Mae and Freddie Mac have access to enough funds for worst case scenario
Based on variable tax assumptions, Fannie Mae and Freddie Mac could need a cash infusion in the range of $68.6 and $157.3 billion from Treasury under the worst case scenario, according to the report. That compares with a range of $84.4 billion to $190 billion projected in the 2014 severe stress test, so it is clear the U.S. economy has improved over the last 12 months
Keep in mind that because of financial agreements with Treasury, both Fannie and Freddie have funds available to them that are greater than the losses modeled even under the “severely adverse” scenario.
Analysts note that because of their bailout agreements with the government, both GSEs are required to send the Treasury most of their quarterly profits, a situation that leaves shareholders with almost no chance for real share price appreciation.