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Update: Partial recap but no release for Fannie, Freddie

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Update: Partial recap but no release for Fannie, Freddie

The Federal Housing Finance Agency said Dec. 21 that housing finance giants Fannie Mae and Freddie Mac would be allowed to reinstate a capital reserve of $3 billion each in order to avoid a draw on taxpayer funds.

Passage of corporate tax reform was expected to put the government-sponsored enterprises in the red by devaluing their significant deferred tax assets. That would have forced an emergency draw from the Treasury Department, an event some observers have referred to as a taxpayer bailout of the enterprises.

The companies have been in government conservatorship since the financial crisis. An agreement with the Treasury Department in 2012, often referred to as the "profit sweep," required Fannie and Freddie to send their net income to Treasury in the form of a preferred stock dividend. Meanwhile, they were allowed to retain a dwindling buffer of capital for themselves, a buffer that was set to hit zero in 2018. Any losses reported after Jan. 1, 2018 — including an accounting loss caused by the devaluation of deferred tax assets — would have needed a draw on the Treasury's funds to keep the GSEs afloat.

In the Dec. 21 announcement, the Federal Housing Finance Agency said the Treasury Department agreed to change the agreement and allow a capital reserve of $3 billion for each enterprise. However, the GSEs are remaining under government control, with no change to their conservatorship status. Shares of both Fannie and Freddie jumped after the announcement only to give back the gains. Both stocks were up between 1% and 2% as of 11:40 a.m. ET.

The statement acknowledged that "it is apparent that a draw will be necessary" for both Fannie and Freddie because of tax reform, a possibility considered nearly a year ago in the wake of President Donald Trump's election.

The surprise announcement comes on the heels of months of hand-wringing over how to address the capital retention question, and how to reform the housing agencies, which continue to trade common stock. Investors have hoped for a fundamental change in the GSEs' status, which currently straddles public and private ownership. Wide-ranging reform proposals have ranged from exiting conservatorship and privatization, which could dramatically raise the value of the company's equity, to dismantling the companies altogether, wiping out the common stock and reshaping the landscape of housing finance in the U.S. Recapitalization has often been proposed in tandem with the companies leaving government control, an idea proponents have called "recap and release."

Allowing the companies to retain capital but keeping them under government control treads a middle ground that Mel Watt, the director of the Federal Housing Finance Agency, has supported. In his testimony before a Senate committee in May, Watt wrote that he could ask the GSEs to begin retaining their earnings as capital. But in October, Watt said he favors a legislative solution to any action the FHFA and Treasury could take on their own.

Some lawmakers, such as Rep. Ed Royce, R-Calif. and Rep. Sean Duffy, R-Wis., have pushed for congressional action in 2017. But like earlier attempts at legislative fixes, those efforts have fallen by the wayside as other, high-profile legislation, from healthcare reform to work on a tax cut, commanded Congress' attention this year.

When reached for comment, the offices of Royce and House Financial Services Committee Chairman Jeb Hensarling, R-Texas, expressed disappointment at the decision. "Instead of a capital buffer, we should be talking about resolving the issue once and for all," Royce wrote. Hensarling described the return of a capital buffer at the GSEs as a rollback of "vital taxpayer protections."