The Bush administration is considering whether to fold Fannie Mae and Freddie Mac's $5.2 trillion in debt into the federal budget, the White House budget office and the US Treasury Department said.
“We're discussing how to present this in the federal budget with Treasury and stakeholders right now, but a conclusion hasn't been determined,'' said Corinne Hirsch, a spokeswoman for the Office of Management and Budget. The Government Accounting Office and other federal agencies are also weighing in on the issue.
The federal takeover of the government-sponsored enterprises, or GSEs, on Sept 7 failed to address whether the debt of Fannie and Freddie should be included in the budget, or whether it carries an explicit government guarantee. In an interview this week, Treasury Secretary Henry Paulson cited the “incongruities” in the law and said “we should be clear, is there a government guarantee or isn’t there?”
Any decision to add Fannie and Freddie to the budget wouldn't automatically translate into an explicit government backing for the companies' combined $1.7 trillion in unsecured debt and $3.5 trillion of mortgage guarantees. Granting the full faith and credit of the US would require an act of Congress to change the companies' legal status.
“You can’t even be a senior debt investor at this point beyond the 15 month period because you really don't know if the federal government will back away from its commitment to support the debt,'' said Christopher Sullivan, who oversees $1.3 billion as chief investment officer at United Nations Federal Credit Union in New York.
The Treasury is talking to the budget office about how to treat Fannie and Freddie in the budget, said Jennifer Zuccarelli, a Treasury spokeswoman. She declined to discuss what options are being considered.
''The reason Fannie Mae was originally turned into a GSE was to take it off the budget,'' said Peter Wallison, a fellow at the American Enterprise Institute, a conservative policy think tank in Washington. Wallison was general counsel for the Treasury during the Reagan Administration. ''The U.S. budget is a completely cash flow system, it's like a Mom and Pop candy store. They don't have any reserves or deferred expenses like private corporations do. It's completely cash in, cash out.''
The Treasury and Federal Housing Finance Agency put the beleaguered mortgage-finance companies back under federal control for the first time in about 40 years after their $14.9 billion in net losses threatened to further disrupt the housing market. The Treasury committed to invest as much as $200 billion in preferred stock and extend credit through 2009 to prevent a collapse of Fannie and Freddie, protecting investors owning more than $5 trillion of their debt and mortgage-backed securities.
Treasury Risk
If the companies were given explicit backing, their debt costs would plunge to bring them closer to the U.S. Treasury debt, Wallison said.
Fannie's five-year debt trades at 65 basis points more than Treasuries and has averaged 40 basis points more for the past five years.
Investors in the credit-default swap market for U.S. Treasuries are already concerned a guarantee is coming, demanding record high fees to offer investors protection against losses on Treasuries.
Five-year credit-default swap contracts on U.S. government debt increased 3.5 basis points on Sept. 9 to a record 18, up from 6 basis points in April, according to CMA Datavision in London. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a country or company fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality.
Losses
The U.S. budget deficit will grow next fiscal year to $438 billion from $407 billion, the Congressional Budget Office said Sept. 9, making it harder for President George W. Bush's successor to either cut taxes or increase spending.
The CBO, a provider of independent assessments on U.S. economic and budgetary decisions to Congress, said the Treasury should incorporate Fannie and Freddie's assets and liabilities into the budget. The CBO, which doesn't set budget policy, will include the projections in its own data starting in January.
''What the administration chooses to incorporate in its budget is up to them, but we hope they will agree,'' CBO Director Peter Orszag said in an interview yesterday.
Though much of the companies' unsecured debt will likely be counted as new federal debt, their mortgage securities won't necessarily translate into the same amount of federal debt since loans and other assets back those liabilities, Orszag said.
The degree of government control suggests the companies' expenses, including salaries and electricity bills, should be counted as federal spending and all fee revenue and other income from operations should be reflected as revenue, Orszag said.
CBO will treat Fannie and Freddie's debt similar to that of government-owned electricity producer Tennessee Valley Authority, which Orszag said won't directly affect the federal debt ceiling.
Any cash investments by the Treasury, such as buying mortgage securities or preferred stock, will directly add to the federal debt outstanding. U.S. officials said Treasury plans to buy $5 billion of the companies' mortgage bonds this month. Fannie and Freddie are also issuing $1 billion each this week in senior preferred shares to Treasury without any cost to the U.S. government.
