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Despite rightward shift in Washington, a clouded future for Fannie, Freddie

On Nov. 30, Steven Mnuchin seemed to confirm what Fannie Mae and Freddie Mac investors had hoped for following Donald Trump's surprise win earlier in the month: The new administration would try to release the beleaguered agencies from conservatorship.

"We've got to get Fannie and Freddie out of government ownership," the nominee for Treasury secretary said during a Fox Business interview, responding to whether he would try to have the two government-sponsored enterprises privatized. "We'll make sure that when they're restructured, they'll be safer and they don't get taken over again, but [we've] got to get them out of government control."

The GSEs' shares, which had risen when Trump was declared president-elect, jumped again to nearly triple their pre-election prices following Mnuchin's statement.

While Munchin's comments galvanized shareholders, remaking the housing market — which relies on a broad GSE presence to keep mortgage rates low and de-risk home loans — remains a difficult task, experts say. The conversation in Washington about GSE reform has shifted to the right, with a dialogue emerging between a group of lawmakers who want Fannie and Freddie eliminated without replacement and another faction who would see them wound down but replaced with a different model for supporting the housing market.

Neither idea resembles a "recap and release" plan, in which the two agencies would exit conservatorship and be allowed to recapitalize, or rebuild the profits and capital they currently send directly to Treasury. This idea — simply returning Fannie and Freddie to the way they were before the crisis, without any substantial reform to show for the years they spent in conservatorship — has little support among Republicans in Congress, Jim Parrott, a senior fellow at the Urban Institute and former economic adviser in the Obama administration, said in an interview.

Rather, Parrott said, if a solution emerges in 2017 it will likely fall between two proposals. One is a comparatively moderate plan supported by Republican Sen. Michael Crapo of Idaho and Tim Johnson, the South Dakota Democrat and former senator, that would replace the GSEs with a single agency, a private capital buffer and an explicit government guarantee to cover catastrophic losses. The other position, held by Rep. Jeb Hensarling, R-Texas, and others, calls for housing finance to be a fully private market without a government-sponsored presence.

Both ideas were presented in Congress in 2013 but did not advance to the floor.

"So legislative reform is likely to be played out in a dialogue between those two groups. How does that anti-government influence affect more mainstream views of reform?" Parrott said. "And then the x-factor is where the Trump administration falls in all of this."

Mnuchin's comments were viewed by shareholders as aligning more with a recap-and-release plan, which, if realized, would immediately drive up the value of those shares. While both GSEs are quasi-government entities, they also have common shareholders, who have waged a yearslong campaign in court to reverse a part of the GSEs' conservatorship structure that forces them to send all profit above a set amount to Treasury in the form of a dividend. The amount of capital the GSEs are allowed to keep has declined each year and is set to hit zero in 2018. The agencies are able to draw on Treasury funds if they declare a negative net worth, a scenario that grows more likely as their capital shrinks.

While a recap-and-release solution has little to no support among Republicans in Congress, the Treasury Department could act on its own to undo the so-called profit sweep agreement that siphons capital from the GSEs. However, the Federal Housing Finance Agency, an independent agency not under Treasury's purview, is their direct regulator, and FHFA Director Mel Watt, a Democrat, could resist unilateral action from Treasury, Moody's wrote in a Dec. 5 report.

"Mr. Watt has given no indication that he believes the GSEs are healthy enough to end conservatorship," Moody's analyst Brian Harris wrote. Watt's term ends in 2019.

But Mnuchin may be forced into action by one of the Trump administration's top priorities: lowering the corporate tax rate in the U.S. from 35%, where it currently stands, to 15%. In annual filings to the SEC made in February, both Fannie and Freddie cited a lower corporate tax rate as a risk factor because the lower rate would lower the value of each agency's net deferred tax assets.

"The deferred tax asset has to be recalculated on a present-value basis, and that will result in a clear charge to the earnings of both companies" if the corporate rate is lowered, Rafferty Capital Markets analyst Richard Bove said in an interview. Fannie and Freddie had about $35.10 billion and $18.73 billion, respectively, in net deferred tax assets as of Sept. 30, according to the companies' most recent quarterly filings. Each will receive a capital base of only $600 million for each quarter of 2017, according to their agreement with Treasury.

Other accounting losses also could occur, as they did in the third quarter of 2015 and the first quarter of 2016, when Freddie declared net losses but avoided a Treasury draw because its net worth was still positive.

In the meantime, the FHFA expects Fannie and Freddie to continue on the path laid out in its annual scorecard, which it uses to evaluate the GSEs. The 2017 scorecard, released Dec. 15, lists expanding liquidity in the housing market, reducing taxpayer risk through credit-risk transfers to the private sector, and building out the common securitization platform for issuing new mortgage-backed securities as the GSEs' core duties for the year.