Update on Fannie Mae and Freddie Mac

Published with Edward J. Pinto in Housing Finance International Journal.

Since the fall of the American savings and loan industry four decades ago in the 1980s, U.S. housing finance credit has been dominated by the tightly government-connected firms of Fannie Mae and Freddie Mac. Until 2008, Fannie and Freddie were privately owned, privately managed companies, but they were always completely dependent on the guarantee they enjoy from the U.S. Treasury. They still are dependent on it and will continue to be. This guarantee now totals $7.6 trillion (that’s “trillion” with a “T”). It is not explicitly written down, but it is certainly a liability of the government; it is said by all to be an “implicit guarantee.” No informed person doubts that it is a real obligation of the government. We feel sure that that includes the officers of the U.S. Treasury.

This guarantee is egregiously provided to Fannie and Freddie for free. Neither has ever paid even one cent for it. It is part of the government’s attempt to promote housing, not to mention helping out the important political constituencies of the housing and housing finance industries that benefit from it. Fannie and Freddie could not exist for even a day without this huge and extremely valuable government guarantee, which, because it is free, acts as a giant subsidy.

Fannie and Freddie used frequently to claim that this institutional design, with them at the center of a taxpayer-guaranteed housing finance system, was “the envy of the world.” It wasn’t, but it did make and still makes the U.S. unique in global housing finance.

With the collapse of the great housing bubble which greeted the opening of the 21st century, Fannie and Freddie went broke and were recapitalized by the U.S. Treasury in a $190 billion bailout, making good the government’s guarantee and making whole every creditor. The government also took over complete control of the management of Fannie and Freddie. They are thus no longer privately owned and managed companies and can no longer properly be called, as they used to be, “government-sponsored enterprises.” Instead, they have become overwhelmingly government-owned and entirely government-controlled companies—simply part of the U.S. government.

The Treasury’s equity stake in Fannie and Freddie is now $367 billion. This is the liquidation preference of their combined senior preferred stock. Subtracting this government stake from the total equity of $179 billion leaves Fannie and Freddie with a private equity of negative $188 billion. On top of owning the bulk of the equity through its senior preferred stock, the Treasury has the right to acquire 79.9% of Fannie and Freddie’s common stock almost for free—the exercise price of the option it holds is one-thousandth of a cent per share. Hard to get closer to zero than that.

The Director of the Federal Housing Finance Agency, in his legal role as Conservator, has had total governance power over Fannie and Freddie since 2008. Under the law, the Conservator wields the power of the boards of directors and the executives, as well as being the regulator. He has moreover made himself Chairman of both of the boards. As Director of the FHFA, he is responsible to and removable by the President of the United States. A pointed recent example of Fannie and Freddie’s current governance was the instruction from the President for them to buy for their portfolio $200 billion of mortgage-backed securities. The FHFA Director announced that Fannie and Freddie would execute the order and they obeyed.

Fannie and Freddie’s primary ownership by the government and total governance by the government has so far lasted nearly 18 years. It has outlasted numerous attempts at legislative reform and many proposals for what has been called “privatization” but never really was, because all these proposals include maintaining the free government guarantee. In our opinion there is no credible escape from the current situation and it is likely to continue indefinitely.

As part of the government, Fannie and Freddie have become even bigger than they were before. With combined assets of $7.8 trillion and $7.6 trillion in liabilities, they are an essential part of the finances of the U.S. government. That the Treasury guarantees those trillions in liabilities means that they are in reality part of the government’s debt. Accurately reporting this $7.6 trillion as government debt, which it really is, would increase the reported U.S. government debt held by the public by about 25%—from $30.8 trillion to $38.4 trillion as of December 31, 2025. The even larger category of total U.S. government debt would increase to the pretty astonishing amount of $46.1 trillion.

Naturally there is a strong desire of politicians and Treasury managers to keep Fannie and Freddie’s debt off the government’s books. Nonetheless, that is where it belongs. We are not betting on its being properly reported there any time soon, however.

Fannie and Freddie operate at extremely high, non-market, government-guaranteed leverage. Their leverage and most of their profit is made possible by their free guarantee from the Treasury.

An essential question to understand Fannie and Freddie’s true nature is: What would happen to Fannie and Freddie if they had to pay a fair price for their guarantee? Of course, that includes the question: What would a fair price be?

There are two components to the guarantee fee Fannie and Freddie should pay the Treasury. First is the Risk Fee for the risk that Fannie and Freddie impose on the Treasury of future losses and future bailouts. The second is the Cost Offset Fee to make up for the increase in the cost of the Treasury’s own debt that Fannie and Freddie cause.

We estimate the Risk Fee by the close analogy to what the largest, “Too Big to Fail” banks pay the Federal Deposit Insurance Corporation for the implicit guarantee of all of their liabilities which they too receive from the government. We believe the Risk Fee should be about 12 basis points (0.12%) of Fannie and Freddie’s total liabilities per year. For the combined $7.6 trillion in liabilities, this fee would be $9.1 billion per year. To pay that would take about 36% of Fannie and Freddie’s combined 2025 pretax profit.

Further study may determine that the fair Risk Fee is higher or lower. In any case, it is absolutely certain that the right fee is not zero, which it has always been up to now.

The Cost Offset Fee reflects the fact that the constant presence of trillions of dollars of Fannie and Freddie mortgage-backed securities and debt compete with the Treasury’s own debt for the purchases of conservative global investors. Using and updating the Federal Reserve’s analysis of the relationship of the effects of Fannie and Freddie’s MBS on the cost of U.S. Treasury debt, the AEI Housing Center estimated the fair level of the Cost Offset Fee to be from 38 to 57 basis points (0.38% to 0.57%) per year on Fannie and Freddie’s liabilities, or a mid-point of 48 basis points (0.48%). This would just reimburse the Treasury for the added interest cost that Fannie and Freddie impose on it.

Adding together the two components of the appropriate guarantee fee gives an estimated total fee of 60 basis points (0.60%). To give Fannie and Freddie the benefit of the doubt, we cut this in half, to 30 basis points (0.30%).

What is the resulting effect of Fannie and Freddie? To pay the 30 basis point guarantee fee would require $22.8 billion, which is about 90% of their combined 2025 pretax profits. Others may of course have differing estimates of the right fee for Fannie and Freddie to pay the Treasury for the guarantee which makes their existence possible, but any legitimate fee would constitute a very significant portion of their pretax profits.

This result speaks to an essential truth: the essence of Fannie and Freddie is to convert a free government guarantee into their profit. If it is ever contemplated to move them out of the government and again into private ownership and management, this absolutely has to be fixed, which means adopting a fair guarantee fee they have to pay the U.S. Treasury. But such a fee makes it impossible for the potential private investors to want to invest.

The alternative, which we expect to continue, is for Fannie and Freddie to go along indefinitely under government ownership and government control, the 20th century idea of “government-sponsored enterprises” having failed.