Let’s begin with the $10 billion in combined earnings that Fannie and Freddie generated in the fourth quarter of 2016. That money is supposed to be delivered to the Treasury on March 31, under a change to the taxpayer rescue made by the Obama administration back in 2012. That change required Fannie and Freddie to deliver essentially every nickel they make to the Treasury’s general fund each quarter; previously, they had been required to pay a percentage of the $187 billion they received in the taxpayer bailout that kept the companies afloat during the financial crisis.
The government has argued that it changed the terms of the 2008 rescue almost five years ago because Fannie and Freddie were in a death spiral and taxpayers needed to be protected from additional losses. But this stance was undercut last year by the release of documents in a shareholder suit showing that the profit sweep came after Obama administration officials had been advised that Fannie and Freddie were about to become profitable again. If President Trump wants to continue the previous administration’s practice of seizing all of Fannie’s and Freddie’s profits, his administration will allow that $10 billion to be swept, on schedule, into the Treasury’s general fund at the end of this month. If the administration does not want to follow this path, it can hit the pause button and let those earnings remain at the companies as capital.
Diverting Fannie’s and Freddie’s profits has been a bonanza for Treasury; if the last quarter’s payment goes through, the companies will have delivered $78 billion more to the government than they received during the financial crisis.
That’s one luscious honey pot. But there are a few reasons a new administration may want to stop dipping into it.
First, the quarterly payments have left Fannie and Freddie dangerously undercapitalized, with the thinnest of cushions to protect against future losses. Investors have sued the government over the profit sweep, contending that it was a breach of contract and an improper taking of private property without just compensation. Both of these legal arguments are moving forward through various courts.
But an even more compelling reason Mr. Mnuchin may want to let Fannie and Freddie hang on to their earnings has to do with Mr. Trump’s promise to big business to lower corporate tax rates steeply. If the plan he has outlined goes through, the value of certain assets held on Fannie’s and Freddie’s balance sheets would decline significantly.
In the face of such a drop, the companies would have to write down the assets. And given that the companies have almost no capital cushion, they would have to draw money from Treasury to cover the losses associated with the write-downs.
Credit
Al Drago/The New York Times
The assets that could be subject to a write-down came about during the mortgage crisis, when Fannie and Freddie were generating losses. Under accounting rules, when money-losing companies become profitable again — as both Fannie and Freddie did in 2013 — they are allowed to use past losses to reduce taxable income in the future. Losses that can be used in such a way become deferred tax assets.
As of September 2016, the value of both companies’ deferred tax assets stood at $53.8 billion. But under a lower corporate tax rate, the value of those deferred tax assets declines, as Fitch Ratings noted in a report dated last Tuesday. If corporate tax rates fell to 20 percent from the current 35 percent, for example, the companies would have to write down the value of those assets by $23 billion, Fitch said, creating the need for a taxpayer draw to cover those losses.
Needless to say, this would not be desirable. And it would certainly seem to be something the Trump administration would not want to occur on its watch, especially since it had nothing to do with creating the profit sweep.
I asked the Treasury if it might be considering allowing Fannie and Freddie to hold on to their earnings from the fourth quarter and subsequent quarters to protect against a taxpayer draw. A spokeswoman did not respond to a request for comment.
This brings me to the second decision the Trump administration must soon make regarding Fannie and Freddie: Will its Justice Department continue to fight the investor lawsuits as aggressively as the department did under Mr. Obama? Or will the new administration throw in the towel, deciding these are battles it’s not keen to keep waging?
We will most likely know the answers to those questions by April 17. That’s the deadline the government has just been given to produce thousands of documents it has been withholding from plaintiffs in one of the shareholder cases.
In a ruling Tuesday, Margaret M. Sweeney, the judge hearing the case in the Court of Federal Claims in Washington, ordered the government to produce documents relating to the 2012 profit sweep. The main plaintiff, the mutual fund company Fairholme Funds, argues that the government improperly seized private property when it started diverting the profits.
In litigating the matter, Mr. Obama’s Justice Department requested extreme secrecy. It withheld more than 11,000 documents from plaintiffs relating to the profit decision, arguing that the material was subject to various claims of privilege, including those covering deliberative process and presidential communications.
If Mr. Trump wants to continue the fight taken up by his predecessor, his Justice Department will battle Judge Sweeney’s order. If he has no appetite for such a skirmish, the documents may finally emerge.
Privilege logs provided to the court show that these materials consist of emails about the profit sweep, internal government memos and confidential briefing documents among high-ranking officials at the White House, Treasury and the Federal Housing Finance Agency, which oversees Fannie and Freddie.
It is not clear, of course, what the documents contain. But it’s a good guess they might provide further confirmation that the government knew the companies were about to become profitable when it changed the terms of the rescue, gaining access to Fannie’s and Freddie’s earnings to pay for something or other.
I asked the Justice Department how it planned to respond to Judge Sweeney’s order to produce the documents.
A spokeswoman there declined to comment. But we’ll know soon enough.
