Could Fannie and Freddie Pay Back Taxpayers Someday?

by 23 May 2012

(Wall Street Journal) -- Conventional wisdom holds that taxpayers will never recoup the money they’ve poured in to prop up Fannie Mae and Freddie Mac, the government-controlled mortgage giants whose rescue has cost taxpayers nearly $150 billion to date.

That assumption is false, says Jim Millstein, a former Treasury Department official. Mr. Millstein oversaw the government’s rescue of insurer American International Group, which like Fannie and Freddie nearly failed in 2008.

Mr. Millstein, a longtime investment banker who now heads his own restructuring firm, has a plan for the government to be repaid on its investment in Fannie and Freddie.

The idea is for Fannie and Freddie to be spun off from the government as private companies again. This time, however, they would have solid protection against potential losses rather than the thin capital cushions that contributed to their near-failure. And a new government agency would provide a further backstop.

How would Fannie and Freddie effectively reboot their operations? Mr. Millstein proposes that the mortgage giants stop paying the 10% annual dividend they currently must pay to the Treasury at a cumulative cost of $41 billion to date. They would also pour their earnings into the creation of an “enormous” capital cushion of around $120 billion to $140 billion to absorb losses. That would be about four times the size of the cushion before Fannie and Freddie’s takeover.

The government would convert the preferred stock holdings in Fannie and Freddie into common shares and gradually sell off those holdings, hypothetically starting to repay taxpayers by 2016. Fannie and Freddie’s mortgage holdings and debt, meanwhile would be spun off into a “bad bank” structure.

“We can re-engineer Fannie and Freddie’s (finances)…so as to put them on path so they can actually pay the taxpayers back,” Mr. Millstein said in a presentation at the Woodrow Wilson International Center for Scholars in the nation’s capital. “Not a small consideration in a town looking for money.”

Mr. Millstein is a strong believer that the government needs to play a role in supporting the U.S. mortgage system. As such, he supports the creation of a new federal agency – the Federal Mortgage Insurance Corp. – that would provide a guarantee for mortgages and ensure that credit is still available. Fannie and Freddie would pay for this guarantee, as could banks and other private firms.

“This can be done,” Mr. Millstein said, “it’s not that hard.”

The problem, however, is that it may not be politically feasible, as it assumes that Fannie and Freddie will continue to exist, albeit in a far more regulated form.

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