The Rescue of Fannie Mae and Freddie Mac – Module C: GSE Credit Facility

As the housing correction worsened and the outlook for Fannie Mae and Freddie Mac deteriorated, government officials ramped up efforts to pass legislation to create a new, more powerful GSE regulator with the authority to properly mitigate concerns at the entities and to rescue them, if necessary (FCIC 2011b). Government officials worried that the Office of Federal Housing Enterprise Oversight [OFHEO], then the safety and soundness regulator of the GSEs, had insufficient authority over the two entities and possessed no viable mechanism to rescue the GSEs should they verge on disorderly collapse (FCIC 2011b, 312-318; Frame et al. 2015, p. 18).

On July 30, 2008, in response to pleas from federal financial officials, the US government adopted the Housing and Economic Recovery Act (HERA) (FCIC 2011b, 316-317). In addition to creating a new, more powerful GSE regulator (FHFA) with the authority to impose higher capital standards and to sanction unsafe behavior, HERA also significantly increased the government’s capacity to respond to a crisis (FCIC 2011b, 316-317). More specifically, HERA granted the Treasury the power to act as a financial backstop for the GSEs, subject only to its determination that such an action was necessary to preserve the stability of the mortgage market and the financial system more generally (HERA).

After making such a determination, Treasury could purchase an unlimited amount of the GSEs’ capital securities or debt, so long as such purchases took place before December 31, 2009, when Treasury’s authority to purchase these instruments was set to expire (Treasury 2008b). In September 2008, Treasury established the Credit Facility, entered into the SPSPAs, and launched the GSE MBS purchase program pursuant to the new funding authority granted by HERA (Treasury 2008b).

On September 7, 2008, Treasury and the FHFA announced a four-part rescue plan designed to prevent the insolvencies of Fannie Mae and Freddie Mac as well as the parallel collapse of the mortgage market, consisting of (1) placing the two GSEs into conservatorships, (2) entering into the SPSPAs, (3) establishing the Credit Facility for each entity, and (4) launching the Treasury GSE MBS purchase program (Treasury 2008b).

The rescue plan was designed such that each component addressed a particular set of constraints confronting Fannie Mae and Freddie Mac (Treasury 2008b). The role of the Credit Facility was to provide a liquidity backstop for the GSEs, ensuring their access to stable funding should demand for their debt securities take time to recover (Treasury 2008b).

Unlike their standing lines of credit from Treasury—which afforded each GSE a maximum of $2.25 billion—the Credit Facility offered the GSEs the opportunity to borrow an unlimited amount from Treasury, although—in keeping with requirements set by HERA—this funding could not extend past December 31, 2009 (Treasury 2007; Treasury 2008b). By design, the Credit Facility was unlimited, in effect serving as a full liquidity backstop for the GSEs during its lifetime (Treasury 2008b). Although the government never explicitly stated how much it realistically would have committed to the GSEs, HERA raised the federal debt limit by $800 billion (FCIC 2011b, 317).

The initial interest rate on loans was set at LIBOR of a comparable duration plus a premium of 50 basis points (Treasury 2008a). The rate was set at the discretion of Secretary Paulson consistent with the credit line being “an ultimate liquidity backstop” and was intended to protect the taxpayers (Treasury 2008a; Treasury 2008b, 3). As a result, the GSEs were incentivized to obtain funding elsewhere, if available. As it turned out, the GSEs were able to satisfy their funding requirements elsewhere on more favorable terms, and thus never utilized the Credit Facility (Fannie Mae 2009, 125-126; Freddie Mac 2009, 126-127).

Under the Credit Facility, loans could be extended for terms ranging from seven to 30 days (Treasury 2008a). The creation of a short-term lending facility reflected Treasury’s attempt to address the short-term funding constraints experienced by the GSEs (Treasury 2010, GSE-3). In addition, the Credit Facility complemented rather than overlapped with funding available to the GSEs pursuant to the SPSPAs (Treasury 2008b). At the same time, shorter loan terms also functioned to better protect the taxpayer against possible instability (Treasury 2010, GSE-3).

All loans extended through the facility were required to be secured by satisfactory collateral, which Treasury defined only as agency mortgage-backed securities and FHLB advances (Treasury 2008a). As of June 30, 2008, the GSEs collectively held more than $600 billion of their own securities, thus making the Credit Facility a viable source of substantial funding, if needed^FThis figure accounts only for securities of their own held by Fannie Mae and Freddie Mac, and not each other’s. (Fannie Mae 2008, 91; Freddie Mac 2008, 33). Treasury was responsible for setting collateral margins on loans, while the Federal Reserve Bank of New York was responsible for valuing and managing the collateral submitted by each GSE. Treasury viewed haircuts to collateral as a measure to protect taxpayers from the risk of lending to potentially unstable firms (Treasury 2008a; Treasury 2010, GSE-3).