Last week, the Federal Housing Finance Agency (FHFA) put Freddie and Fannie to the test, and the results were grim. Dodd-Frank mandated “stress tests,” designed to evaluate a financial institution’s ability to withstand an economic downturn, revealed that in a severe recession Fannie and Freddie could require bailouts of as much as $190 billion, a staggering figure considering the $187.5 billion these agencies received in the wake of the last housing crisis.
As dictated by the terms of their previous bailouts, Fannie and Freddie’s excess profits (which were at record highs last year) above minimum net worth thresholds are remitted to the U.S. Treasury. The GSEs’ resulting lack of capital explains their poor performance under pressure.
Just days before the stress tests, the Senate Banking Committee postponed voting on a bill to wind down Fannie and Freddie over the course of the next five years. Thanks to the lobbying efforts of the GSEs and private investors, as of April 29th that bill lacked the votes in the Senate Banking committee that it needed to make it to the Senate floor for a vote.
However, regardless of whether the GSEs are phased out, the stress test results should be taken into consideration going forward. If Fannie and Freddie are continually required to remain undercapitalized, absent another bailout, they will never be able to withstand another housing crisis.