The Rescue of Fannie Mae and Freddie Mac-Module B: Senior Preferred Stock Purchase Agreements

Through 2007 and 2008, as the housing market experienced an unprecedented correction, two government-sponsored enterprises (GSEs), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), continued to buy and guarantee loans, which provided the secondary mortgage market with much-needed liquidity (FCIC 2011, 309-10). This was a critical role in stabilizing the market, since by 2008, the private secondary market had all but collapsed. By the fourth quarter of 2007, the GSEs had increased their share of purchases of mortgage originations to 75%, nearly twice their 2006 level (FCIC 2011, 312). For 2007, as mortgage defaults mounted and market prices of mortgage-linked securities fell, the GSEs reported annual net losses of $2.1 billion for Fannie Mae (first since 1985) and $3.1 billion for Freddie Mac (first ever) (OFHEO 2008, 10–11). The contracting mortgage market and the GSEs’ recognized instability also made it difficult for the two companies to raise capital (FCIC 2011, 314–315).

By September 2008, when the government intervened, the two GSEs’ outstanding guaranteed mortgage-backed securities (MBS) and debt totaled more than $5 trillion, and they had capital of only 2% (FCIC 2011, 312). Recognizing Fannie Mae’s and Freddie Mac’s importance to the contracted mortgage market, federal officials aimed to preserve GSE operations, particularly since many investors believed that the GSEs were backed by an implicit guarantee from the federal government (FCIC 2011, 316). Officials understood that the GSEs’ insolvency would have geo-economic repercussions, since foreign institutions (mostly central banks) held $1 trillion in GSE debt and MBS (Paulson 2010).

Fannie Mae’s and Freddie Mac’s worsening health increased decades-old concerns that their regulators, the Office of Federal Housing Enterprise Oversight (OFHEO) and the Department of Housing and Urban Development (HUD), might not be able to properly stabilize the GSEs; the regulators had no authority to increase the firms’ capital requirements (FCIC 2011, 309). Congress passed the Housing and Economic Recovery Act (HERA) on July 30, 2008, which created a new GSE regulator, the Federal Housing Finance Agency (FHFA), with enhanced supervisory authorities, and enabled it to take control of Fannie Mae and Freddie Mac, if necessary (HERA 2008). Section 1117 of the bill also gave Treasury emergency powers, expiring on December 31, 2009, to “purchase any obligations and other securities issued by [Fannie Mae and Freddie Mac]” (HERA 2008).

On September 6, 2008, the FHFA took the GSEs under conservatorship as part of a four-part program designed to stabilize Fannie Mae and Freddie Mac.^FNSee Thompson and Wiggins (2021) for more discussion of the conservatorship. See also Vergara (2021) for discussion of the Credit Facility and Zanger-Tishler and Wiggins (2021) for discussion of the GSE Purchase Program, the other components of the rescue plan. Wiggins et al. (2021) discusses the overall intervention effort. The Senior Preferred Stock Purchase Agreements (SPSPAs) were entered into the next day. Although Fannie Mae and Freddie Mac each signed a separate agreement with Treasury (with the FHFA acting on behalf of the GSEs as conservator), the agreements were substantially the same, and so we discuss them as one herein. Figure 1 depicts the overall timeline of the SPSPAs.

Note: If the above topics were not amended, assume that they remained unchanged.
ˡ Terms are denoted per GSE.

The SPSPAs were established pursuant to Treasury’s authority under HERA. The agreement was structured as a sale from the GSE to the Treasury of certain Variable Liquidation Preference Senior Preferred Stock (SPS) and a warrant, with the SPS representing an in-kind payment of an Initial Commitment Fee for Treasury’s commitment (the Commitment) to provide funds to the GSE from time to time in amounts needed to offset any losses that it incurred (Treasury/Fannie 2008). Treasury’s original commitment was for up to $100 billion for each GSE (Treasury/Fannie 2008).

If the FHFA, as conservator, concluded that a GSE’s net worth for any quarter was less than zero, it could request a draw under the SPSPAs equal to the GSE’s net deficit (Treasury/Fannie 2008). Treasury would pay the amount requested within 60 days of such a request, provided that the amount requested and all previous draws did not equal or exceed the maximum amount that Treasury was then committed to provide (Maximum Amount). If the amount requested and previous draws exceeded the Maximum Amount, Treasury would provide such lesser amount that was available.

The FHFA was given three different timing windows to request a draw: (1) the FHFA could request a draw every quarter, (2) the FHFA could request an immediate draw if it decided to take the GSEs into receivership, and (3) the FHFA could request an immediate draw if it decided to liquidate the firms (Fannie 2008a). In the latter case, the FHFA would calculate the draw based on the GSEs’ liquidation date balance sheet (Fannie 2008a). The draws allowed the GSEs to maintain a positive net worth every calendar quarter, allowing them to fulfill senior and subordinated debt obligations and to continue to guarantee their MBS throughout the crisis (FHFA 2010).

In exchange for its funding commitment, each GSE issued to Treasury (1) 1,000,000 shares of SPS with an initial Liquidation Preference^FNTerms used herein and not defined herein refer to the defined terms as used in the SPSPA. of $1,000 per share ($1 billion aggregate Liquidation Preference) and (2) a warrant to purchase common stock representing 79.9% of the common stock of the GSE on a fully diluted basis for $0.00001 per share. The GSEs also agreed to adhere to certain obligations and restrictions contained in the SPSA agreement (Treasury/Fannie 2008). 

(1) Senior Preferred Stock. The SPS was senior to all other common and preferred stock, but junior to senior and subordinated debt (Frame et al. 2015). The SPS was perpetual and thus had no specified date of maturity (Jester et al. 2018). Per Treasury’s initial purchase, the Liquidation Preference of the SPS was set to $1,000 per share (Fannie 2008a). As discussed herein and noted in Figure 2, three factors could increase the initial aggregate Liquidation Preference of $1 billion: (1) the amount of any draws paid by Treasury to the GSE, (2) accrued but unpaid dividends, and (3) any Periodic Commitment Fees that the GSE chose to pay by adding them to the Liquidation Preference (Treasury/Fannie 2008; Fannie 2008a). Draws from Treasury under the SPSPAs constituted the main source of increase of the Liquidation Preference over time.

The GSEs could pay down the Liquidation Preference but not below the initial value of $1,000 per share while the Commitment was in force (Fannie 2008a). Upon the voluntary or involuntary dissolution, liquidation, or winding up of a GSE, Treasury would be entitled to receive from the assets of the GSE available for distribution to stockholders, before any payment or distribution could be made on the common stock or any other class or series of stock of the GSE ranking junior to the SPS upon liquidation, the Liquidation Preference plus any dividends accrued pro rata for the current period (Fannie 2008a). Upon termination of the Commitment, the GSE could voluntarily pay down the Liquidation Preference in whole or in part (Fannie 2008a).

As of July 2017, Fannie Mae’s Liquidation Preference was valued at $117.1 billion, and Freddie Mac’s was valued at $72.3 billion (Fannie 2017; Freddie 2017).

ˡ As of third quarter 2017. Sources: Fannie 2008a; Freddie 2017; Fannie 2017.

The SPS was to pay a quarterly dividend in arrears based on the dividend rate multiplied by the then Liquidation Preference. Treasury set the dividend rate at 10%, believing this fairly reflected market rates on comparable securities (Jester et al. 2018). If the GSE failed to pay a dividend on time, (1) the unpaid dividend would be added to and increase the Liquidation Preference, and (2) the dividend rate would rise to 12% and remain at that increased rate until the GSE paid all cumulative but unpaid dividends (including dividends added to the Liquidation Preference) (Fannie 2008a). With respect to dividends and distributions upon dissolution, liquidation, or winding up, the SPS ranked above the GSE’s common stock, all other outstanding preferred stock, and all other capital stock to be issued.

The GSEs also were required to pay a Periodic Commitment Fee, accruing from January 1, 2010, and payable quarterly beginning March 31, 2010, to compensate Treasury for its ongoing commitment under the SPSPAs after December 31, 2009 (Treasury/Fannie 2008). The FHFA and Treasury—in consultation with the Fed—were to decide the amount of the Periodic Commitment Fee, which would be applicable for a five-year period (and reset every five years) (Treasury/Fannie 2008). Treasury could at its discretion waive the Periodic Commitment Fee at the beginning of the year based on adverse conditions in the mortgage market (Treasury/Fannie 2008). The GSE could at its discretion choose not to pay the Periodic Commitment Fee in cash but have it added to the aggregate Liquidation Preference (Treasury/Fannie 2008). Treasury, however, waived the Commitment Fee for each quarter beginning in March 2010 until it suspended the fee in the third amendment. Since Treasury never collected a Commitment Fee, the dividend constituted the GSEs’ sole cash transfer to Treasury. The quarterly dividend payments began to accrue on September 8, 2008, the day after the announcement of the SPSPAs (Fannie 2008a).

(2) The Warrants. In addition to the SPS, Treasury also immediately received from each firm a warrant to purchase up to 79.9% of the firms’ common stock on a fully diluted basis. The warrant had a 20-year term with a nominal exercise price, initially $0.00001 per share (Fannie 2008b). As of this case’s writing, Treasury has not exercised the warrant.

(3) Additional Guidelines and Restrictions. The SPSPAs required the GSEs and the FHFA to adhere to additional operational guidelines and restrictions, most importantly portfolio and debt limits. The SPSPAs set the GSE portfolio cap at $850 billion, which required a 10% annual reduction that began in 2010. However, the GSEs did not have to reduce their portfolio below $250 billion. The GSEs could not increase their debt levels to more than 110% of their debt on June 30, 2008, which was $859.9 billion for Fannie Mae and $956.5 billion for Freddie Mac (Fannie 2008c; Freddie 2009a).

Without Treasury’s approval, the FHFA could not end the conservatorships, unless it moved the GSEs into receivership (Fannie 2008a). In addition to debt and portfolio limits, the SPSPAs required the GSEs to seek Treasury approval to: issue or purchase stock, pay any dividends (apart from those owed to Treasury), alter executive compensation, enter into new contracts, or consolidate or merge with another company. Without Treasury’s approval, the GSEs could not sell, convey, or transfer any of its assets, except for dispositions for fair-market value:

• To a limited-life regulated entity;
• “In the ordinary course of business, consistent with past practice”;
• During a liquidation of the GSE;
• Of cash (or equivalent) for cash (or equivalent); or
• To stay within the debt limit (Treasury/Fannie 2008).

The First Amendment. On May 6, 2009, in response to changes in the market, Treasury and the FHFA amended the SPSPA, raising Treasury’s Commitment (and thus the Maximum Amount) from $100 billion to $200 billion per GSE (UST/Fannie 2009a). Treasury and the FHFA raised the GSEs’ portfolio cap from $850 billion to $900 billion and derived the 10% reductions (to begin in 2010) from the $900 billion cap (for example, the cap would be $810 billion by end year 2010) (FHFA 2010). The amendment also raised the GSEs’ debt ceiling to $1,080 billion in aggregate par value debt (FHFA 2010). The $1,080 debt cap was based on 120% of $900 billion, the GSEs’ new portfolio cap. The debt cap decreased by 10% annually beginning in 2010, since its maximum value was calculated using 120% of the GSEs’ portfolio cap (FHFA 2010).

The Second Amendment. The FHFA and Treasury amended the SPSPAs again on December 24, 2009, just as the Treasury GSE MBS Purchase Program and Treasury Credit Facility were expiring.^FNSee Zanger-Tishler and Wiggins (2021) and Vergara (2021) for discussion of the Treasury GSE MBS Purchase Program and the Treasury Credit Facility, respectively, the additional components of the government’s GSE intervention. The December amendment increased Treasury’s commitment to $200 billion plus any draws during 2010, 2011, and 2012, less any surplus amount that existed on December 31, 2012. In other words, Treasury would not count draws requested in 2010, 2011, and 2012 as part of its $200 billion commitment, effectively providing the GSEs with unlimited draws during these years (UST/Fannie 2009b).  

The Third Amendment. The third amendment was entered into on August 17, 2012 (effective as of January 1, 2013). It increased the GSEs’ portfolio cap reduction from 10% to 15% per year, but not below $250 billion (UST/Fannie 2012). The amendment also capped the GSEs’ capital reserves at $3 billion (UST/Fannie 2013) and required reductions of $600 million annually until they reached zero by January 2018. At that point, the GSEs would depend on Treasury funds to cover their losses (UST/Fannie 2013). This reflected a “wind down” strategy favored by the Obama administration.

The third amendment also required Fannie Mae and Freddie Mac to submit an annual risk management plan to Treasury, including a detailed explanation of how each company planned to reduce its operations and curb taxpayer losses. The third amendment added a sixth exception to the GSE asset transfers (see previous page for the original five), allowing the GSEs to dispose of any assets that were valuated at $250 million or less without Treasury’s approval (UST/Fannie 2013).

The third amendment also altered the SPSPA’s dividend structure, replacing the 10% (or 12%, if delinquent) fixed dividend with a variable dividend (UST/Fannie 2012). This policy was enacted to protect the taxpayer and also to avoid the practice of the GSE borrowing from the SPSPAs to pay the dividend, which then increased the Liquidation Preference and future dividends (Thompson and Wiggins 2021). From January 1, 2013, until December 31, 2017, for any quarter, the variable dividend rate included the net worth amount from the previous quarter (if positive), less the maximum allowed capital reserve amount. Fannie Mae and Freddie Mac would not pay a dividend if their net worth fell below the capital threshold. From January 1, 2018, onward, the dividend would consist of the net worth amount, as the capital reserve amount would be zero (UST/Fannie 2012). In effect, the variable dividend rate and other terms adopted in the amendment limiting the firms’ accumulation of capital reserves amounted to a quarterly net sweep of any GSE profits to Treasury.

December 2017 Letter Agreement. In December 2017, the Trump administration Treasury Department and the FHFA entered into a letter agreement that raised the maximum capital reserve amount for each firm from zero (as mandated by the third amendment) to $3 billion indefinitely, beginning in January 2018, permitting the firms to again retain earnings. Per the third amendment, the dividend payment would consist of any positive net worth less $3 billion, or the applicable capital reserve amount. It’s not clear if this should be read as a definite shift from the prior administration’s “wind down” strategy for the firms. The letter also mandated that $3 billion be added to the Liquidation Preference of the GSEs’ SPS (UST/Fannie 2017). In addition, Treasury asserted that the $3 billion capital buffer depended on the GSEs’ ability to continue paying dividends. According to a press release by Treasury, “any failure by Fannie Mae or Freddie Mac to declare and pay a full quarterly dividend will result in the automatic, immediate termination of its capital buffer” (UST/Fannie 2017).

Commenting on the letter agreement, the FHFA director argued that:

While it is apparent that a draw will be necessary for each Enterprise if tax legislation results in a reduction to the corporate tax rate, FHFA considers the $3 billion capital reserve sufficient to cover other fluctuations in income in the normal course of each Enterprise’s business. We, therefore, contemplate that going forward Enterprise dividends will be declared and paid beyond the $3 billion capital reserve in the absence of exigent circumstances (Treasury 2017).

Termination of Commitment. Treasury and the FHFA could terminate the SPSPAs for three reasons. First, if the liquidation end date occurred and Treasury had supplied all the requested funds for the liquidation end date. Second, if the GSE repaid, defeased, or completed by another provision its mortgage guarantee obligations and debts. Third, if Treasury injected the full amount of its commitment into the GSEs (Treasury/Fannie 2008). The status of the FHFA’s conservatorship would not affect the SPSPA, and the SPSPAs would continue even if the FHFA placed the GSEs into a receivership or “any other insolvency proceeding” (Treasury/Fannie 2008).

A GSE could pay down the Liquidation Preference in whole or in part, but only in cash. As shown in Figure 3, any such paydown would be first applied to offset any unpaid dividends, and then any unpaid Periodic Commitment Fees, that had been added to the Liquidation Preference. The GSE was required to pay down the Liquidation Preference (in the stated order) if it issued any shares of capital stock in exchange for cash while the SPS was outstanding. However, if the Commitment had not yet terminated, the Liquidation Preference could not be paid down below the initial $1 billion (Treasury/Fannie 2008). If the GSE paid down the Liquidation Preference to zero after termination of the Commitment, the SPS would be deemed to have been redeemed and no longer outstanding. As of this case’s publication, however, the GSEs remain in conservatorship, the SPS remains outstanding, and the SPSPAs are still in effect.

Following the conservatorship announcement on September 7, 2008, market demand for GSE debt seemed to increase (Federal Open Market Committee 2008). However, the GSEs’ common stock fell to about $1 (from approximately $60 per share the previous year). Preferred shares did not fare much better (Frame et al. 2015). In addition to the issuance of senior preferred stock to Treasury, the FHFA’s decision to freeze private equity likely contributed to the downturn in stock prices (FHFA 2017).

Mortgage yields also fell for a brief period. The Monday following the intervention (September 8), the rate on Fannie Mae’s five-year debt and its mortgage-backed securities (MBS) dropped about 30 and 50 basis points, respectively (using five-year Treasury bond yields as the spread). More broadly, mortgage rates fell by 50 basis points. Following Lehman Brothers’ collapse on September 15, however, mortgage rates rose and quickly exceeded levels that Fannie Mae and Freddie Mac had experienced prior to the conservatorship (Frame et al. 2015).

From 2008 through third quarter 2017, Fannie Mae drew an aggregate $116.15 billion under the SPSPA, while Freddie Mac drew an aggregate $71.34 billion, requesting only quarterly draws. The largest draws occurred during the first year of the conservatorship. Fannie Mae drew a peak sum of $19 billion in first quarter 2009, while Freddie Mac drew a peak sum of $30.8 billion in fourth quarter 2009. The GSEs have not requested a draw since first quarter 2012 (see Appendix A). After Treasury expanded its funding cap in December 2009, Fannie Mae had $124.8 billion and Freddie Mac had $149.3 billion in commitment available from Treasury, which amount remains available as of this case’s publication (despite draws received in 2010-2012) because of the nature of the adjusted formula for accounting for draws adopted with the second amendment (Appendix A).

Treasury and the FHFA passed the third amendment under more stabilized conditions for the housing market and for the GSEs. In 2012, Fannie Mae and Freddie Mac posted annual profits (after paying dividends to Treasury) for the first time since 2007. When the GSEs became profitable in 2012, they reevaluated their deferred tax assets, which only increased profits further. Tax reevaluation enabled the GSEs to realize record-breaking profits in 2013, with Fannie Mae realizing $58.7 billion in the first quarter and Freddie Mac netting $30.4 billion in the third quarter (Frame et al. 2015).

From 2008 to 2012, Fannie Mae and Freddie Mac paid an aggregate $23.75 and $31.43 billion in dividends, respectively, as shown in Figures 4  and 5. From first quarter 2013 to third quarter 2017, Fannie Mae and Freddie Mac paid $86.39 billion and $134.31 billion in dividends, respectively. Through third quarter 2017, Fannie Mae and Freddie Mac have paid an aggregate $276.8 billion to Treasury dividends and have received $187.5 billion in draws, which have increased the combined Liquidation Preference to $189.5 billion (Fannie 2017; Freddie 2017). As of July 2017, Fannie Mae’s Liquidation Preference stood at $117.1 billion and Freddie Mac’s Liquidation Preference stood at $71.3 billion.(Fannie 2017; Freddie 2017).

Source: FHFA 2019

Notes: Timeline: from September 2008 until September 2017. Red denotes enactment of new variable dividend formula.  Source: FHFA 2019

The GSEs never exceeded their established portfolio caps or debt ceilings. Fannie Mae’s peak portfolio was $817.8 billion in June 2010 (Fannie 2010). Freddie Mac’s peak portfolio was $867.1 billion in March 2009 (Freddie 2009b). Fannie Mae came closest to the debt ceiling in November 2008, with $885.6 billion (Fannie 2008c). Freddie Mac held a peak debt of $932.4 billion in March 2009 (Freddie 2009b). Per the third amendment, capital reserves were to be decreased by $600 billion pursuant to a schedule, and were anticipated to reach zero in January 2018 (FHFA OIG 2013).

In December 2017, the Trump administration Treasury Department and the FHFA entered into a letter agreement that raised the maximum capital reserve amount for each firm from zero (as mandated by the third amendment) to $3 billion indefinitely, beginning in January 2018 permitting the firms to again retain earnings. It’s not clear if this should be read as a definite shift from the prior administration’s “wind down” strategy for the firms. The letter further stipulated that $3 billion be added to the liquidation preference of the preferred stock (UST/Fannie 2017; Thompson 2021).

On September 30, 2019, the FHFA and Treasury announced that they had amended the SPSPAs to permit GSEs to retain additional earnings in excess of the $3 billion capital reserves permitted under the third amendment. The letter agreement would permit Fannie Mae and Freddie Mac to maintain capital reserves of $25 billion and $20 billion, respectively. To compensate Treasury for the dividends that it would have received absent these amendments, the liquidation preferences for the SPS will gradually increase by the amount of the additional capital reserves until the liquidation preferences increase by $22 billion for Fannie Mae and $17 billion for Freddie Mac (FHFA 2019).

On November 18, 2020, the FHFA announced a final rule setting forth new capital requirements for the GSEs (2020 Enterprise Capital Rule) and on January 2021, the Treasury and the FHFA announced that they had further amended the SPSPAs to allow the GSEs to continue to accumulate reserves until they had satisfied the requirements of the rule (FHFA 2020; FHFA 2021b). Based on their assets as of June 30, 2020, the firms would have been required to hold $283 billion in unadjusted total capital (Passy 2021).

Since the beginning of the conservatorship and the SPSPA, many individuals and entities, mainly shareholders, have sought damages from the FHFA. Several of these cases are still unresolved (see discussion at “Evaluation” and accompanying footnotes). The conservatorship and the SPSPAs are still in effect.