The Rescue of Fannie Mae and Freddie Mac – Module D: Treasury’s GSE MBS Purchase Program

The GSE MBS Program was authorized under HERA, which was adopted in July 2008 (HERA 2008). Treasury officials recognized the systemic importance of Fannie Mae and Freddie Mac, which, as of the end of 2007, financed or guaranteed 50% of outstanding residential mortgages; officials further anticipated that the firms might not be able to survive the housing correction on their own (FCIC 2010, 17). By the end of 2007, the entities were purchasing 75% of new mortgages, two times the level of a year earlier, a strong indication of how the private securitization market had dried up (FCIC 2011b, 312).

HERA provided several broad authorities to the Treasury Secretary, the newly created FHFA, and Federal Reserve, which led to creation of a four-part rescue plan in September 2008, and included the GSE MBS Program (US Treasury 2008a). The Secretary’s use of the granted authority was conditioned on a finding that an emergency existed, in other words, that such actions were necessary to:

• “provide stability to the financial markets;
• “prevent disruptions in the availability of mortgage finance; and
• “protect the taxpayer” (HERA 2008, Sec. 1117[a]).

Treasury’s September 7, 2008, press release affirmed these objectives as support for the rescue plan (US Treasury 2008a).

The fate of Fannie Mae and Freddie Mac differed from that of other large companies that came under severe financial duress during the fall of 2008 (FCIC 2011b, 319–321). The government was proactive in evaluating the decline of the companies, sought expanded remedial authority, and proactively crafted a solution before the companies faced imminent failure (FCIC 2011b, 319–321). This is most likely due to their status as GSEs, the recognized fact that the companies’ concentration in the housing finance market was systemic, and that there existed an implied governmental guarantee that was known to have been relied upon by investors (US Treasury 2008a).

The GSE MBS Program was announced in conjunction with the conservatorship of Fannie Mae and Freddie Mac and was part of the four-part rescue plan designed to prevent the GSEs’ collective insolvency and the concomitant collapse of the housing market (US Treasury 2008a). The primary goal of Treasury’s GSE MBS Program was to maintain the secondary housing finance market, which in conjunction with the other emergency actions was meant to achieve the overall objectives of the rescue plan. (US Treasury 2008a).

By the fall of 2007, private MBS securitization had been severely constricted as investors shied away from real estate assets (FCIC 2011b, 311–312). Large lenders began holding loans that they had previously securitized (FCIC 2011b, 309). Some smaller lenders that could not sell their loans failed, and others told the GSEs that they too would fail if the GSEs did not continue to purchase their loans (FCIC 2011b, 310). In August 2007 the GSEs asked their regulators to expand their ability to purchase more loans, a request that was originally denied, but was later granted in mid-September, as the mortgage market became even more constricted (FCIC 2011b, 309–312). By the fourth quarter of 2007, the GSEs were purchasing 75% of new mortgages, twice the 2006 rate (FCIC 2011b, 312).

The companies’ weakened states would not allow them to continue purchasing mortgages at historic rates^FIt is worth noting that the Office of Federal Housing Enterprise Oversight (OFHEO), the GSEs’ regulator prior to FHFA, made several deregulatory efforts to shore up confidence for the GSEs by reducing their regulatory burdens during the worst of the market downturn. In mid-September 2007, OFHEO increased the firms’ allowable investment portfolios by about $7 billion address the contraction in the mortgage market—even though OFHEO officials recognized that the firms were in a weakened state at the time (FCIC 2011b, 311–312). OFHEO also loosened the GSEs’ capital requirements from 30% to 20% in March 2008, with the aim of helping the GSEs raise new capital from private investors (FCIC 2011b, 313–315). Though Fannie Mae kept up its end of the bargain and was permitted to lower its capital requirements by an additional 5%; Freddie Mac failed to raise new capital, and market confidence for both enterprises continued to plummet through June 2008 (FCIC 2011b, 315). (US Treasury 2008a). Yet, without a viable secondary market, the mortgage market would have continued to contract, disabling not only housing but potentially the wider economy as well (US Treasury 2008a). By purchasing MBS issued by the firms, Treasury attempted to maintain the secondary market for mortgages, in effect stepping in to perform a role that the GSEs could no longer play for themselves and providing confidence to investors (US Treasury 2008a). However, it was critical that the GSE MBS Program be part of a comprehensive plan (US Treasury 2008a). Stabilizing the GSEs might not have been enough to prevent the collapse of the housing market if they could not continue to purchase and guarantee loans at least at traditional rates (FCIC 2011b, 309–310). Moreover, if Treasury merely backstopped the secondary market without the other elements (capital and liquidity), the firms still might have collapsed and sent shockwaves throughout the market and the economy (US Treasury 2008a).

Pursuant to the enactment of HERA, the Treasury Secretary was authorized to purchase any obligation or other security issued by the GSEs on such terms and conditions as he determined (HERA 2008). However, the GSE MBS Program, as established, was limited to purchasing only MBS issued by Fannie Mae and Freddie Mac (HERA; US Treasury 2008a). Treasury purchased $220.8 billion (face value) in GSE MBS pursuant to the program: $114.8 billion of Fannie Mae MBS, and $105.9 billion of Freddie Mac MBS, which was consistent with the stated aim of the rescue plan (FHFA 2014; US Treasury 2008b). The department purchased the GSE MBS in the open market rather than from the enterprises directly (OIG 2013, 13).

This had several benefits. First, it helped to maintain the flow of funding to mortgage originators and thus the availability of new mortgage financing, as the GSEs continued buying mortgages to bundle into its MBS, a critical need since private securitization had drastically contracted. (US Treasury 2008a). This, in turn, was intended to have a positive effect on mortgage affordability (US Treasury 2008a). Last, by purchasing in the open market rather than from the GSEs directly, the program supported the weakened market for new GSE MBS by stimulating the private market rather than by merely replacing it. Investors would be more likely to purchase new GSE MBS given the possibility that they could also sell the securities if need be.

HERA granted Treasury temporary, but unlimited, authority to invest in the GSEs and their securities and obligations, terms that Secretary Paulson had pushed for (HERA; FCIC 2011b, 316-317). HERA also granted discretion to the Treasury Secretary to determine when to exercise such purchasing authority and the scale of such exercise (US Treasury 2008b).

Pursuant to this authority, the GSE MBS Program was announced without any authorized amount or limit (other than limits related to Treasury debt limit) (US Treasury 2008a; FCIC 2011b, 317). This open-ended announcement was done primarily to signal to the markets and investors (1) Treasury’s willingness to purchase as much MBS as necessary, and (2) that the size of the problem was not known (Paulson 2010, Ch. 7). It also signaled that the Treasury Secretary and department would be closely monitoring developments in the capital and housing markets and stood ready and able to act accordingly (US Treasury 2008a).

Treasury began to make purchases of GSE MBS in September 2008 from the open market and continued to make purchases each month thereafter (FHFA 2014). Monthly amounts purchased from the GSEs varied widely from $0.9 billion to a high of $18.1 billion and amounts purchased from each GSE fluctuated (FHFA 2014). Purchases were conducted by the financial agents at the direction of Treasury, which continuously monitored the agents’ activities (OIG 2013, 4–6, 13). Ultimately, Treasury purchased a total of $225 billion of agency MBS prior to the expiration of its purchasing authority in December 2009 (OIG 2013, 13).

Trading in MBS is a complex and sophisticated skill that requires specialized knowledge, technology, and other resources (US Treasury 2011b). Treasury did not engage in such trading on an ongoing basis (US Treasury 2011b). Moreover, it would have demanded considerable resources for Treasury to hire appropriate staff into the Department at a time when they were already strained and would have diverted existing staff from other critical matters they were dealing with during the crisis (US Treasury 2011b; OIG 2013, 6). Such a project would also have taken time, potentially delaying the implementation of the program.

Instead, Treasury chose independent financial advisers with expertise in trading GSE MBS to administer the GSE MBS Program and used a multi-tiered selection process to find the advisers that would best assist with the program’s objectives (US Treasury 2008b; OIG 2012, 3–7). Treasury ultimately selected two advisers, State Street and Barclays, to build competition into the process, and so that no single agent would know Treasury’s entire trading strategy (OIG 2012, 4–5). Utilizing independent advisers enabled the department to tap the best experts in the area and to quickly operationalize the GSE MBS program (OIG 2012, 3–7). Financial advisers also promoted efficiency and the minimizing of operational and financial risks (OIG 2012, 5–6). 

Treasury began evaluating potential advisers in late August, announced the rescue plan on September 7, signed FAA agreements on September 15, and made its first purchases on September 23, 2008 (US Treasury 2008a; OIG 2012, 16–17).  Treasury staff monitored the agents’ activities and trades and instructed them on the purchases (OIG 2013, 4–6). According to OIG, Treasury failed to adequately document its agency-selection process before the program began as well as the oversight processes after the program was up and running (OIG 2012, 3–7; OIG 2013, 4–6). In response, Treasury reported that it had intentionally deployed personnel to other critical crisis management efforts, rather than expend the resources to document the financial agent selection and oversight processes. They argued that the completion of normal administrative processes could have been counterproductive to Treasury’s overall crisis response (OIG 2012, 2–7; OIG 2013, 4–6).

Under HERA and the GSE MBS Program, it was within Treasury’s discretion to decide how long to hold the MBS that it purchased, including retaining the securities until their maturity (US Treasury 2008b). In March 2011, when Treasury announced that it would begin the sale and wind-down of its portfolio of MBS, it also stated that the market for the securities had greatly improved (US Treasury 2011a). Sales were to be conducted at a “gradual and orderly pace to maximize the recovery of taxpayer dollars and help protect the process of repair of the housing finance market” (US Treasury 2011a). Sales could occur daily but would not be conducted at pre-scheduled times or in pre-announced sizes of individual trades (US Treasury 2011b, 3). Sales would be in amounts up to $10 billion per month, subject to adjustment per market conditions (US Treasury 2011b, 3).

State Street managed MBS sales with the assistance of Smith Graham Investment Advisors, which Treasury hired as a contractor (OIG 2013, 13; US Treasury 2011b, 6). At the announced rate, Treasury expected to have disposed of the portfolio within a year and to return a profit to the taxpayers after fully winding down the portfolio (US Treasury 2011a; US Treasury 2011b, 1).

Treasury concluded its sales of MBS on March 19, 2012 (US Treasury 2012). In total, sale of Treasury’s GSE MBS portfolio, originally acquired at a cost of $225 billion, generated revenue of $250 billion, returning to taxpayers a profit of $25 billion from sales, principal, and interest (US Treasury 2012).

Fannie Mae and Freddie Mac were systemically important to the residential finance market and their shares, debt, and MBS were widely held by many investors including financial institutions, pension funds, state and local governments and foreign central banks (US Treasury 2008a). Any failure or deterioration of the companies could have significant and far-reaching consequences (US Treasury 2008a). Moreover, given the expected size of the GSE MBS program, and the subsequent sales of purchased MBS securities, there would naturally be concern about the impact of such large trades (US Treasury 2011a). Additionally, because of the implied government guarantee, any deterioration of the firms could reverberate negatively and affect the investors’ attitudes towards the US government’s debt (Paulson 2010, Ch. 1).

Mindful of these concerns, Treasury undertook to maintain transparency with respect to the GSE MBS Program and communicated frequently regarding its rationale and actions. The press releases and other public communications relating to the program shared the following characteristics:

• placed the GSE MBS Program within the context of the broader rescue plan for Fannie Mae and Freddie Mac,
• discussed the program’s implications for the housing finance market, and
• conveyed a message that Treasury was constantly monitoring the markets and could and would adjust its activities as market conditions warranted.

Press releases, and the Frequently Asked Questions (FAQs)^FFor example, the FAQs accompanying the announcement of the sale of the portfolio discuss what information would be made available and when and explain the department’s rationale (US Treasury 2011b). Treasury also published a monthly report of broker-dealer market shares for MBS sales, which was intended to “both maximize taxpayer returns and provide additional transparency” (US Treasury 2011b). that accompanied them, provided additional program details and anticipated concerns (US Treasury 2008a; US Treasury 2008b; US Treasury 2011a; US Treasury 2011b). Data regarding the amount of GSE MBS purchases, and then sales (broken down by coupon and agency), were included in the Final Monthly Treasury Statement of Receipts and Outlays of the United States Government posted on the department’s website monthly where they were publicly available (FHFA 2014).