Fannie and Freddie Updated Cost Estimates

On Thursday, the Federal Housing Finance Administration (FHFA) announced that the total net cost of the Fannie and Freddie bailout could be as low as $121 billion, or about 0.8% of GDP.  Some misinterpreted the new estimates as a substantial reduction in the cost of the bailout and contrasted the new figure with the $389 billion estimate from the Congressional Budget Office (CBO) from January 2010.  This is comparing apples and oranges:  the much larger CBO estimate covered total subsidy costs to the government, not expected cash outlays.  In truth, the estimate is essentially the same as CBO’s June 2011 estimate, which estimated net cash payments would peak at a little more than $130 billion.

The new $121 billion figure is also questionable in and of itself, as it deducts $99 billion in dividends expected to be paid to the Treasury. The Treasury had to borrow the funds it provided to bailout Fannie and Freddie and it is wrong to ignore this cost.  Regardless of your views on whether the 10% dividend rate is excessive, any calculation of a net subsidy figure should not ignore the opportunity cost of capital entirely.  At the very least, the government’s 2% average borrowing cost should be used to calculate the net bailout costs, which would put the (net) cost in the $141 billion range.*  More significantly, the main source of the reduction in the net cost comes from dividends paid out of gross income from 2012 to 2014.  This means that the new lower bailout figure will only come to fruition if Fannie and Freddie generate large profits from dominating the mortgage markets for the next several years.  This is good news?

This also relates back to the original CBO estimate.  The total cost of the government’s bailout involves not just cash payments, but the implied cost of financial guarantees.  The GSEs charge 0.19% per year for the provision of insurance for which the private sector would charge significantly more.  If it would normally cost 0.75% to guarantee a $200,000 loan, then the GSE subsidy from a 0.19% fee is equal to $1,120 per year.  A borrower’s balance sheet doesn’t need to implode like Solyndra for the federal loan guarantees to carry a cost.  The reduction in expected net cash outlays does not change that fact, or do anything to lower the ultimate costs of the bailout.

* Thus far, Fannie and Freddie have received $169 billion from the Treasury to maintain a positive net worth. Separately, Fannie and Freddie have thus far made dividend payments totally $15 billion and $13 billion respectively to Treasury. Net dividend payments, the draw-down to date from Treasury to support Fannie and Freddie has been $141 billion.