oversight

Fannie Mae and Freddie Mac: Where the Taxpayers' Money Went

Published by the Federal Housing Finance Agency, Office of Inspector General on 2012-05-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

          FEDERAL HOUSING FINANCE AGENCY
            OFFICE OF INSPECTOR GENERAL

          FEDERAL HOUSING FINANCE AGENCY
            OFFICE OFMae
               Fannie INSPECTOR   GENERAL
                         and Freddie Mac:
                Where the Taxpayers’ Money Went




WHITE PAPER: WPR-2012-02                     DATED: May 24, 2012


EVALUATION REPORT: EVAL-2012-XX            DATED: Month XX, 2012
                                           AT A GLANCE
                                       title
           Fannie Mae and Freddie Mac: Where the Taxpayers’ Money Went

Why FHFA-OIG Did This                                     titleFreddie Mac owned or guaranteed mortgages worth more
Evaluation                                                titlethan $5 trillion, nearly half of the U.S. mortgage market.
                                                              They did not have adequate capital reserves to continue
On July 30, 2008, the Housing and Economic                    operating in the face of the growing losses on their
Recovery Act (HERA) was enacted for the purpose of            mortgage portfolios.
strengthening the regulation of the Federal National
Mortgage Association (Fannie Mae) and the Federal             In September 2008, the Enterprises entered
Home Loan Mortgage Corporation (Freddie Mac)                  conservatorships overseen by FHFA, and, to prevent their
(collectively, the Enterprises). Six weeks later, the         insolvency, Treasury began making quarterly capital
Enterprises entered conservatorships overseen by the          contributions to each institution. This money has been
newly created Federal Housing Finance Agency                  used primarily to cover losses stemming from single-
(FHFA). Shortly thereafter, the U.S. Department of            family mortgage loans that the Enterprises had acquired
the Treasury (Treasury) began making quarterly                from 2004 through 2008. In addition, but to a lesser
investments in the Enterprises to prevent their               extent, Treasury’s investments have covered payments of
insolvency because they were rapidly losing billions of       dividends to Treasury as well as losses from investments
dollars. By the end of 2011, U.S. taxpayers had               and other expenses.
invested nearly $185 billion in Fannie Mae and Freddie        Without assistance from Treasury, the Enterprises likely
Mac.                                                          would not have been able to repay their debts or honor
Questions have arisen regarding why Fannie Mae and            their mortgage-backed securities (MBS) guarantees.
Freddie Mac required such federal intervention, how           Further, they would have been unable to finance new
the Enterprises have used Treasury’s extraordinary            mortgages or create new MBS, two of the cornerstones of
investment, and who may have benefited from it. In            the U.S. housing finance system.
this white paper, FHFA’s Office of Inspector General
(FHFA-OIG) attempts to answer these and other                 Conclusion
questions relating to Treasury’s investments in the           U.S. government intervention protected the numerous
Enterprises. Understanding the answers to these               creditors – both domestic and foreign – who had
questions will be important for policy makers as they         purchased bonds and MBS issued by Fannie Mae and
determine the future of the Enterprises and more              Freddie Mac. Allowing the Enterprises to meet their debt
generally the nation’s housing and related financial          and guarantee obligations enabled them to continue to
markets.                                                      support the secondary market. However, the cost of
                                                              rescuing the Enterprises has been high, with total
Discussion                                                    Treasury support for the Enterprises currently expected
When U.S. housing prices stopped their rapid rise and         to range from a quarter to a third of a trillion dollars.
began declining nationwide in 2006-2007,
homeowners started defaulting on their mortgages at
accelerating rates. At that time, Fannie Mae and


White Paper: WPR-2012-02                                                                       Dated: May 24, 2012
TABLE OF CONTENTS
TABLE OF CONTENTS ................................................................................................................ 3
ABBREVIATIONS ........................................................................................................................ 5
PREFACE ....................................................................................................................................... 6
BACKGROUND ............................................................................................................................ 7
      About the Enterprises .............................................................................................................. 7
             Provisions for Loan Losses in the Enterprises’ Portfolios ............................................... 8
             MBS Guarantees ............................................................................................................... 9
             Defaults and Foreclosures ................................................................................................ 9
      The Financial Crisis and Its Effect on the Enterprises .......................................................... 10
             The Crisis........................................................................................................................ 10
                    The Bubble Inflated ................................................................................................. 10
                    The Bubble Burst .................................................................................................... 10
             The Impact ...................................................................................................................... 11
             The Conservatorships ..................................................................................................... 12
ENTERPRISE GAINS & LOSSES 2008-2011 ............................................................................ 17
      Summary of Gains, Losses, and Use of Funds ...................................................................... 17
             Single-Family ................................................................................................................. 19
                    Retained Mortgage Loans ....................................................................................... 19
                    MBS Guarantees .................................................................................................... 19
             Multifamily ..................................................................................................................... 20
             Investments ..................................................................................................................... 21
                    Private-Label MBS .................................................................................................. 21
                    Derivatives .............................................................................................................. 23
             Other Losses ................................................................................................................... 23
             Accounting Adjustments ................................................................................................ 24
             Dividends to Treasury .................................................................................................... 24


              Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                        3
PUTTING THE LOSSES IN PERSPECTIVE: WINNERS AND LOSERS .............................. 25
      Losers: Stockholders ............................................................................................................. 25
      Winners: Holders of Bonds and Guaranteed MBS ............................................................... 25
OUTLOOK: FORECASTING FUTURE GOVERNMENT PAYMENTS ................................ 27
SCOPE AND METHODOLOGY ................................................................................................ 28
APPENDIX ................................................................................................................................... 29
      The Mechanics of Treasury Financial Support of the Enterprises ........................................ 29
             The Draw ........................................................................................................................ 29
             How the Draw is Calculated ........................................................................................... 29
ADDITIONAL INFORMATION AND COPIES ........................................................................ 30




              Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                       4
ABBREVIATIONS
Fannie Mae......................................................................... Federal National Mortgage Association
FHFA ........................................................................................... Federal Housing Finance Agency
FHFA-OIG ...................................... Federal Housing Finance Agency Office of Inspector General
Freddie Mac .................................................................. Federal Home Loan Mortgage Corporation
Ginnie Mae................................................................. Government National Mortgage Association
HERA.......................................................................Housing and Economic Recovery Act of 2008
MBS ..................................................................................................... Mortgage-Backed Securities
PSPAs ....................................................................... Senior Preferred Stock Purchase Agreements
RMBS ............................................................................... Residential Mortgage-Backed Securities
Treasury ........................................................................................ U.S. Department of the Treasury




             Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                 5
                                       Federal Housing Finance Agency
                                         Office of Inspector General
                                               Washington, DC



                                                 PREFACE
FHFA-OIG was established by HERA,1 which amended the Inspector General Act of 1978.2
FHFA-OIG is authorized to conduct audits, investigations, and other studies of the programs and
operations of FHFA; to recommend policies that promote economy and efficiency in the
administration of such programs and operations; and to prevent and detect fraud and abuse in
them. This white paper provides an overview of the purposes of the government’s extraordinary
investments in the Enterprises; the uses to which the proceeds of such investments have been
applied; and the prospects for repayment of the government’s investments.

This white paper was written principally by Senior Investigative Evaluator Bruce McWilliams
and Senior Financial Analyst Alan Rhinesmith. Assistant Inspector General for Evaluations
David Frost and Senior Financial Analyst Timothy Lee contributed to its completion. FHFA-
OIG appreciates the assistance of FHFA and Enterprise staff in completing this paper. It has
been distributed to Congress, the Office of Management and Budget, and others and will be
posted on FHFA-OIG’s website, www.fhfaoig.gov.




George Grob
Deputy Inspector General for Evaluations
FHFA Office of Inspector General




1
    Public Law No. 110-289.
2
    Public Law No. 95-452.


             Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            6
BACKGROUND
Following an unprecedented rise in housing prices, the housing market began collapsing in late
2006. This had widespread, adverse impacts on those financial institutions heavily concentrated
in mortgage financing, such as Fannie Mae and Freddie Mac.

To prevent the Enterprises’ insolvency, Treasury invested approximately $185 billion in them
from September 6, 2008 through the end of 2011. Treasury’s actions have resulted in
controversy and questions have arisen concerning why Fannie Mae and Freddie Mac required
such federal intervention, how the Enterprises have used Treasury’s extraordinary investment,
and who may have benefited from it.

In a nutshell, it is believed that the investment permitted Fannie Mae and Freddie Mac to avoid
insolvency, which, given their dominant position in housing finance and the trillions of dollars of
securities issued, could have caused the collapse of the U.S. housing finance system. Additional
consequences of Treasury’s intervention include that the Enterprises’ shareholders lost almost all
their investments, but the Enterprises’ bond holders and investors in guaranteed mortgage-
backed securities (MBS) were protected. More importantly, homeowners and other participants
in the housing market directly benefited from Treasury’s buttressing of the market.

About the Enterprises

Fannie Mae and Freddie Mac provide liquidity to the housing finance system by supporting the
secondary mortgage market. The Enterprises purchase residential mortgages that meet their
underwriting criteria from loan sellers. The loan sellers can then use the sales proceeds to
originate additional mortgages. The Enterprises can hold the mortgages in their own investment
portfolios or package them into MBS that are, in turn, sold to investors. For a fee, the
Enterprises guarantee the payment of mortgage principal and interest on the MBS they sell.

As depicted in Figure 1, to finance their purchase of billions of dollars of mortgage loans, the
Enterprises: (1) borrow funds from large individual, institutional, and foreign investors; and
(2) create and sell MBS.




            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            7
Figure 1: Overview of Enterprises and Role of FHFA3




Provisions for Loan Losses in the Enterprises’ Portfolios
Inevitably, some homeowners will encounter difficulty making their mortgage payments. If a
homeowner stops making payments, the Enterprise has to
account for the revenue shortfall related to an owned- or      Provision for Loan and
guaranteed-mortgage. The Enterprises have established          Guarantee Losses
                                                               An accounting concept that
special accounts or reserves to cover losses incurred on loans
                                                               refers to the reduction of
they own in their investment portfolios. They typically        current income to establish a
contribute to these accounts every quarter. These quarterly    reserve fund for mortgage
contributions to reserves are called provisions for loan       losses.


3
 Source: General Accountability Office, Financial Audit: Federal Housing Finance Agency’s Fiscal Years 2011
and 2010 Financial Statements, Nov. 2011, Figure 4.


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            8
losses in that they provide against future losses. Provisions
for loan losses – and the reserves they fund – can be                           Default
                                                                                Occurs when a mortgagor
attributable to a specific loan or can be based on the                          misses one or more payments.
general expectation that a portion of the loans in the
portfolio as a whole will default.                                              Mortgage Guarantees
                                                                                Historically, the Enterprises
MBS Guarantees                                                                  purchased mortgages and
                                                                                securitized them, then provided
With respect to mortgage guarantees associated with the                         a guarantee to investors that if
MBS that Fannie Mae and Freddie Mac sell, they collect a                        the mortgagor defaulted, the
monthly fee to ensure the payment of principal and interest                     Enterprise would make timely
to MBS investors. This fee ‒ spread over the life of the                        principal and interest payments
                                                                                to the securitization trust, which
pool of loans that comprise a particular MBS ‒ is intended
                                                                                in turn would make payments to
to cover that small portion of loans that are expected to                       the security holder.
default. And, similar to the practice for the loans they
retain in their own portfolios, the Enterprises establish reserves for losses on the MBS portfolios
they guarantee.4

Defaults and Foreclosures
After a homeowner defaults on a loan that the Enterprises                        Foreclosure
own or guarantee, a loan servicer – typically, a vendor                          The legal process used by a
hired to collect mortgage payments, set aside taxes and                          lender to obtain possession of
insurance premiums, forward principal and interest                               a mortgaged property.

obligations to mortgage owners, and respond to payment
defaults – may commence foreclosure on behalf of the                             Charges Off
                                                                                 An accounting term describing
Enterprises. Foreclosure is designed to recover the                              the elimination of an asset, such
proceeds of a defaulted loan through the sale of the                             as a mortgage loan, from a
mortgaged property. Once the servicer has foreclosed on a                        company’s books. It does not
loan and taken the title on the property, the Enterprise                         necessarily imply a reduction in
                                                                                 the company’s assets,
essentially erases ‒ or charges off ‒ the unpaid mortgage
                                                                                 depending on the allowance
balance from its accounting records. Following charge off,                       established for loan losses.
if the Enterprise sells the property to a third party, the sales
price will offset losses.

The Enterprises aim to contribute to their loan loss and guarantee portfolio reserves sufficiently
to cover these losses. However, with the collapse of the housing market and the ensuing

4
 Fannie Mae uses the term “guaranty fee,” whereas Freddie Mac uses the term “management and guarantee fee.”
This report refers to them both as “guarantee fees.”


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            9
financial crisis, losses on loans and payment on guarantee obligations vastly exceeded the
Enterprises’ abilities to cover their losses.

The Financial Crisis and Its Effect on the Enterprises

The Crisis
The Bubble Inflated

From 2001 until it reached its peak in 2006, the U.S. housing market experienced a rapid
increase in real estate values.5 During this time, prices of single-family homes increased by an
average of more than 12% annually. Home price appreciation was accompanied by a rapid
increase in mortgage indebtedness. Total mortgage debt outstanding in the U.S. more than
doubled, from $5.1 trillion in 2000 to $11.2 trillion in the second quarter of 2008. This swift
escalation of home prices and mortgage indebtedness is often referred to as the “housing
bubble.”

During the housing bubble, Fannie Mae’s mortgage-related assets and guarantees increased from
$1.3 trillion in 2000 to $3.1 trillion in 2008, or approximately 11% annually. Likewise, Freddie
Mac’s mortgage-related assets and guarantees increased from $1 trillion in 2000 to $2.2 trillion
in 2008, or 11% annually.

The Bubble Burst

In 2007, housing prices began to plummet and loan delinquencies and defaults significantly
increased. As reflected in Figure 2, after more than doubling over six years, home prices fell by
27% between 2006 and 2008.




5
    Over a longer period, between 1997 and 2006, home values increased 124%.


             Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            10
Figure 2: Average Single Family Residence Prices, 2000-20116

                    220.00

                    200.00
    Housing Index




                    180.00

                    160.00

                    140.00

                    120.00

                    100.00




The Impact
The collapse of housing prices had widespread adverse impacts on many sectors of the U.S.
economy, particularly for those financial institutions and investors that were heavily
concentrated in mortgage financing such as Fannie Mae and Freddie Mac. The Enterprises had
grown rapidly with only a thin capital cushion to provide protection against losses. The capital
they were required to hold to protect them from losses on their investment portfolio and
guarantee obligations met regulatory standards but fell well below capital levels maintained by
many large financial institutions.7 Hence, the Enterprises were ill-prepared for a sharp

6
 Standard and Poor’s, S&P/Case-Shiller Home Price Indices (Instrument: Case-Shiller 20-City Composite
Seasonally Adjusted, Frequency: Monthly) (online at www.standardandpoors.com/indices/sp-case-shiller-home-
price-indices/en/us/?indexId=spusa-cashpidff--p-us----).
7
    In 2007, Federal Reserve Board Chairman Ben S. Bernanke said:
                       Because of both regulatory requirements and the force of market discipline, banks hold much more
                       capital than GSEs [government-sponsored enterprises] hold. The very largest bank holding
                       companies generally hold equity capital equal to 6 percent or more of assets, and the largest regional
                       banks generally have capital ratios of about 8 percent. (As I am sure you are keenly aware,
                       community banks often have a capital-to-assets ratio exceeding 10 percent.) In comparison, the GSEs
                       hold capital equal to roughly 3.5 percent of assets. The justification for the low capital holdings of
                       GSEs relative to banks is unclear. The largest banks are more diversified than the GSEs; and
                       although banks likely assume greater credit risks, they probably are less subject to interest-rate risk
                       than are GSEs. Moreover, the recent experience of the GSEs suggests that they are subject to at least
                       as much operational risk as the large banks.
Board of Governors of the Federal Reserve System, Statement of Chairman Ben S. Bernanke (Mar. 6, 2007) (online
at www.federalreserve.gov/newsevents/speech/bernanke20070306a.htm).


                         Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                       11
nationwide decline in housing prices. When housing prices for the United States overall fell by
an average of 9% in 2007, the Enterprises’ businesses began to come under increasing stress. By
early 2008, both institutions were experiencing financial difficulties and, as more and more
homeowners became delinquent on their mortgages, their rates of seriously delinquent (i.e., 90 or
more days delinquent) owned- or guaranteed-loans rapidly exceeded levels experienced during
the preceding decade.

The financial crisis has produced unprecedented losses for the Enterprises. Fannie Mae lost $5
billion in the second half of 2007 and another $4.5 billion through the first half of 2008. Freddie
Mac lost $3.7 billion in the second half of 2007 and $1 billion during the first half of 2008.
Subsequently, the collapse in the market for MBS in the fall of 2008 resulted in even larger
losses for both entities. For the full year 2008, Fannie Mae and Freddie Mac together recorded
losses of more than $100 billion ($58.7 billion and $50.1 billion, respectively). To put these
losses into perspective, over the 37 year period from 1971 to mid-2008, Fannie Mae and Freddie
Mac earned $95 billion, less than they lost in 2008 alone. And, the losses continued; from 2008
through the end of the third quarter of 2011, the Enterprises lost $261 billion.8 In other words,
the amount lost during the conservatorships is more than twice as large as the cumulative net
income that the Enterprises reported as public companies.9

The Conservatorships
In July 2008, HERA was enacted. Among other things, HERA strengthened the regulator’s
ability to place the Enterprises in conservatorships and authorized it to place them into
receiverships.10 Additionally, HERA empowered Treasury to provide financial assistance to
Fannie Mae and Freddie Mac through the end of 2009.




8
  Federal Housing Finance Agency, Conservator’s Report on the Enterprises’ Financial Condition, Third Quarter
2011, at 9 (online at http://www.fhfa.gov/webfiles/22855/Conservator'sReport3Q2011F122111F.pdf) (accessed Apr.
16, 2012). This is a comprehensive income figure (upon which Treasury investments are calculated); net income
figures reported by the Enterprises may differ.
As depicted in Figure 5, the Enterprises’ cumulative losses exceed the amount of Treasury’s investment by $78
billion. When the conservatorships commenced, the Enterprises had $78 billion in capital available, and this capital
partially offset losses and the need for additional Treasury investment.
9
 Federal Housing Finance Agency, FHFA Report to Congress 2010, at 114, 131 (online at
www.fhfa.gov/webfiles/21570/FHFA2010RepToCongress61311.pdf) (accessed Feb. 29, 2012).
10
  Under the previous statute governing federal oversight of the Enterprises, the Federal Housing Enterprises
Financial Safety and Soundness Act of 1992, Public Law No. 102-550, the Enterprises’ regulator, Office of Federal
Housing Enterprise Oversight, had the authority to place an Enterprise in conservatorship, but not receivership.


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            12
On September 6, 2008, Fannie Mae and Freddie Mac entered conservatorships overseen by
FHFA.11 Among the key reasons FHFA cited for taking this action were concerns about the
financial conditions of the Enterprises and their ability to raise capital and to continue funding
themselves; FHFA also noted “the critical importance each company has in supporting the
residential mortgage market in this country.”12

At the same time, and in coordination with FHFA, Treasury exercised its authority under HERA
to provide support to the Enterprises to ensure their solvency. In taking this action, former
Treasury Secretary Henry Paulson stated that Treasury had concluded ‒ based on a thorough
review of the financial conditions of the Enterprises, their projected abilities to withstand
difficult market conditions, and the need to provide stability to unsettled financial markets – that
it was necessary both to place them in conservatorships and to set up a process for providing
financial support to them, as needed.13

Treasury’s financial support has been in the form of purchases of senior preferred stock issued
by the Enterprises in accordance with Senior Preferred Stock Purchase Agreements (PSPAs).
Under the terms of the PSPAs, whenever an Enterprise’s
liabilities exceed its assets (as determined using Generally    Generally Accepted
                                                                Accounting Principles
Accepted Accounting Principles (GAAP)), Treasury                (GAAP)
provides sufficient cash to eliminate that deficit in           A set of rules that is agreed
exchange for an increase in the value of the senior             upon by industry boards as
                 14                                             common accounting practices.
preferred stock. The PSPAs thus provide the Enterprises
                       15
a financial backstop. Since establishing the
conservatorships, Treasury has made equity investments in the Enterprises almost every quarter
and, by the end of 2011, the cumulative amount of such taxpayer investments stood at $185
billion, as shown in Figure 3.16

11
  For a more complete discussion of the impact of placing the Enterprises in conservatorships, see FHFA-OIG’s
Current Assessment of FHFA’s Conservatorships of Fannie Mae and Freddie Mac (WPR-2012-001, March 28,
2012) (available at www.fhfaoig.gov/Content/Files/WPR-2012-001.pdf).
12
 Federal Housing Finance Agency, Statement of FHFA Director James B. Lockhart (Sept. 7, 2008) (online at
www.treasury.gov/press-center/press-releases/Documents/fhfa_statement_090708hp1128.pdf).
13
 U.S. Department of the Treasury, Statement by Secretary Henry M. Paulson, Jr. (Sept. 7, 2008) (online at
www.treasury.gov/press-center/press-releases/Pages/hp1129.aspx).
14
  Federal Housing Finance Agency, Mortgage Market Note U.S. Treasury Support for Fannie Mae and Freddie
Mac, at 3 (online at www.fhfa.gov/webfiles/15362/MMNote_10-1_revision_of_MMN_09-1A_01192010.pdf)
(accessed on Feb. 29, 2012).
15
     Id.
16
  This figure, $185 billon, includes the $2 billion initial commitment fee. Treasury was issued stock representing
this fee as payment for agreeing to invest in the Enterprises as required.


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            13
Initially, the Enterprises were to receive from Treasury no more than $200 billion. The PSPAs
were subsequently revised to increase this amount to $400 billion. The PSPAs were amended a
third time to increase the investment ceiling to $400 billion over the amount actually drawn as of
December 31, 2012 (less any positive equity – which is unlikely – at that date). To illustrate,
given the investment of $185 billion at the end of 2011, if no more cash were drawn before
December 31, 2012, (and stockholder equity is zero or less on that date), then the ceiling will be
$585 billion ($185 billion plus $400 billion).

Figure 3: Federal Government Support Since Conservatorship17

                   $200
                   $180                                                                        $185 billion
                   $160
                   $140
      $ Billions




                   $120
                   $100
                    $80
                    $60
                    $40
                    $20
                     $0




                                                 Fannie Mae             Freddie Mac


As a condition of receiving financial support under the PSPAs, the Enterprises agreed to pay
Treasury quarterly dividends. The dividend amounts are based on a 10% annual rate on
Treasury’s outstanding investment.

The Enterprises’ dividend obligations, which are exacerbated by the 10% annual rate, are so
large that they have yet to earn enough to pay them annually. Consequently, Treasury has had to
advance additional sums to the Enterprises to pay dividends. As of the end of 2011, Treasury’s
investment in the Enterprises, excluding the amount needed to fund the dividend payments, is

17
  Federal Housing Finance Agency, Data as of January 2, 2012 on Treasury and Federal Reserve Purchase Programs
for GSE and Mortgage-Related Securities, at Table 1 (online at www.fhfa.gov/webfiles/23193/TSYSupport1312012.pdf)
(accessed Mar. 9, 2012); and Federal Housing Finance Agency, Mortgage Market Note, US Treasury Support for
Fannie Mae and Freddie Mac, page 3 (January 20, 2010).


                   Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                             14
$151 billion.18 (Treasury’s investment of $185 billion also includes $32 billion in dividend
advances and $2 billion in fees assessed against the Enterprises at the inception of the PSPAs.)
According to FHFA and the Enterprises, the likelihood of the Enterprises ever earning enough to
repay the full amount invested is remote.19 This is illustrated in Figure 4, which compares the
current dividend amount to the Enterprises’ net annual income since 1988.

Figure 4: Combined Enterprise Net Income vs. Current Treasury Dividend 20

                                                     Minimum Current Annual Dividend: $19.2 billion
                   $20
                    $0
                   -$20
     $ Billions




                   -$40
                   -$60
                   -$80
                  -$100
                  -$120




On the basis of Treasury’s outstanding investment of $185 billion and the annual dividend rate of
10% (paid quarterly at a rate of 2.5%), the Enterprises’ current annual dividend payment is
$19.2 billion.21 As depicted in Figure 4, even in their best year, 2002, when they earned
18
  Federal Housing Finance Agency, Data as of January 2, 2012 on Treasury and Federal Reserve Purchase Programs
for GSE and Mortgage-Related Securities, at Table 2 (online at www.fhfa.gov/webfiles/23193/TSYSupport1312012.pdf)
(accessed Mar. 9, 2012); Freddie Mac, 2011 10-K Report, at 127 (online at
www.freddiemac.com/investors/sec_filings/index.html) (accessed Mar. 9, 2012); Fannie Mae, 2011 10-K Report, at 9
(online at www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2011/10k_2011.pdf) (accessed Mar. 9, 2012).
19
   The Acting FHFA Director noted in a September 2011 speech: “It ought to be clear to everyone at this point,
given the Enterprises’ losses since being placed into conservatorship and the terms of the Treasury’s financial
support agreements, that the Enterprises will not be able to earn their way back to a condition that allows them to
emerge from conservatorship.” Federal Housing Finance Agency, Statement of Acting Director Edward J. DeMarco
(Sept. 19, 2011) (online at www.fhfa.gov/webfiles/ 22617/NCSpeech91911.pdf). Similarly, in their 2011 annual
public filings, both Enterprises independently reported that, “there is significant uncertainty as to our long-term
financial sustainability.” Freddie Mac, 2011 10-K Report, at 24 (online at
www.freddiemac.com/investors/sec_filings/index.html) (accessed Mar. 9, 2012); Fannie Mae, 2011 10-K Report, at 21
(online at www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2011/10k_2011.pdf) (accessed Mar. 9, 2012).
20
  Source: FHFA annual report to Congress, 2010, p. 113 and p. 114, Fannie 10-K, 2010 and Freddie 10-K, 2010;
Fannie 10-Q, 3rd quarter, 2010 and Freddie 10-Q, 2010.
21
  If the computation were made once a year, then the 10% rate would be assessed against the balance, resulting in a
payment of $18.5 billion.


                          Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                    15
$14 billion, the Enterprises failed to earn the $19.2 billion that would be needed to pay an annual
dividend on Treasury’s $185 billion investment as of the end of 2011.




            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            16
ENTERPRISE GAINS & LOSSES 2008-2011
Summary of Gains, Losses, and Use of Funds

Large businesses like the Enterprises typically analyze financial performance of all of their
business lines to gain an understanding of the dynamics of each particular segment of their
operations. As discussed in more detail below, and as summarized in Figure 5, with the
exception of their multifamily business lines, the Enterprises suffered losses in all of their
operations.

                     Sources of Gains and Losses Between 2008 and Q3:201122 23

                       Single Family Houses                      Loss
                       Multifamily                               Gain
                       Investments                               Loss
                       Other                                     Loss
                       Accounting Adjustments                    Loss
                       Dividends to Treasury                     Dividend Payment



As discussed above, the Enterprises’ cumulative losses as of the end of the third quarter of 2011
total $261 billion, but they had $78 billion in unobligated capital at the beginning of 2008.
(Additionally, $2 billion in fees were assessed against the Enterprises at the inception of the
PSPAs, and these fees are included in Treasury’s $185 billion investment.) This unobligated
capital partially mitigated the need for Treasury investment. Figure 5 quantifies the relative
losses, dividend obligations, and gain on Enterprise operations, through the third quarter of 2011.




22
  FHFA publishes a quarterly conservator’s report on Fannie Mae’s and Freddie Mac’s financial performance and
condition, to enhance public understanding of their financial performance leading up to and during conservatorship,
including the sources of Enterprise losses and capital deficits, and Enterprise loss mitigation activity. See
http://www.fhfa.gov/Default.aspx?Page=172.
23
  “Figure 3.1 Capital Changes: January 1, 2008-September 30, 2011” from FHFA, Conservator’s Report on the
Enterprises’ Financial Performance, Third Quarter 2011, p. 9 (online at
http://www.fhfa.gov/webfiles/16591/ConservatorsRpt82610.pdf).


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            17
Figure 5: Enterprise Gains/Losses 2008 Through Q3:201124 25
                   $20
                                               $7
                    $0
                                                              -$4           -$16             -$8
                   -$20
                                                                                                             -$32
                   -$40

                   -$60
     $ Billions




                   -$80

                  -$100

                  -$120
                                                                     Available Capital               $ 78 Billion
                  -$140
                                                                     Loss from Segments             -$261 Billion
                  -$160                                              Initial Commitment Fees        -$ 2 Billion
                                                                     Total                          -$185 Billion
                  -$180

                  -$200      -$208

                  -$220




Figure 5 clearly demonstrates that the bulk of the Enterprises’ losses were incurred in its single-
family business: owning and guaranteeing home mortgages. Moreover, the vast majority of the
Enterprises’ losses in their single-family business lines are attributable to single-family loans
made from 2004 through 2008.


24
      Numbers do not total due to rounding.
25
   “Figure 3.1 Capital Changes: January 1, 2008-September 30, 2011” from FHFA, Conservator’s Report on the
Enterprises’ Financial Performance, Third Quarter 2011, p. 9. (online at
http://www.fhfa.gov/webfiles/16591/ConservatorsRpt82610.pdf).


                      Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                18
Single-Family
As discussed above, the Enterprises purchase single-family mortgages from lenders. The
Enterprises then either hold the mortgages in their investment portfolios or package and sell them
as MBS. The Enterprises typically guarantee payment of principal and interest on the MBS they
sell in exchange for guarantee fees.

As shown in Figure 5, after accounting for revenues from new and existing loans (e.g., guarantee
fees), the Enterprises’ single-family business line had a net loss (i.e., expenses exceeding
income) of $208 billion since 2008. As described below, and depicted in Figure 6, Fannie Mae’s
and Freddie Mac’s loss-related expenses totaled $218 billion, and these expenses were
predominantly associated with MBS guarantees.

Retained Mortgage Loans

During the conservatorships, the Enterprises accrued $86
                                                               Reserve for Guarantee
billion in expenses (called “provisions”) related to           Losses
mortgage loans held on their books, as shown in Figure 6.      An accounting phrase meaning
However, this sum is affected by a recent accounting           to establish a reserve fund on
change. Prior to 2010, these losses related solely to those    the balance sheet in anticipation
                                                               of future losses for loans
loans the Enterprises purchased from third-parties and
                                                               guaranteed by the Enterprises.
immediately placed into their portfolios (without              It has the effect of reducing
securitizing and selling them to investors). Beginning in      income in the current period.
2010, changes in accounting rules required the Enterprises
to account for loans they had guaranteed in the same way as loans they owned and held on their
books. Thus, the Enterprises reduced their reserve for MBS guarantee losses and increased
their reserves for retained mortgages losses.

MBS Guarantees

The Enterprises expanded their MBS business rapidly
                                                                                Securitization
beginning in the mid-1990s. By 2008, the amount of the                          A process whereby a financial
Enterprises’ guarantees on mortgages that were securitized                      institution assembles pools of
into MBS was nearly seven times the amount held in their                        income-producing assets (such
                                                                                as loans) and then sells an
investment portfolios.26 As the housing market collapsed
                                                                                interest in the assets’ cash
and homeowners failed to make interest and principal                            flows as securities to investors.
payments for securitized loans, the Enterprises satisfied
26
  Fannie Mae, 2008 10-K Report, at 170 (online at www.fanniemae.com/ir/pdf/earnings/2008/form10k_022609.pdf)
(accessed Mar. 12, 2012); Freddie Mac, 2008 10-K Report, at 127 (online at
www.freddiemac.com/investors/er/pdf/10k_031109.pdf) (accessed Mar. 29, 2012).


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            19
their guarantee obligations and made required periodic payments to MBS investors. As shown in
Figure 6, in spite of the 2010 accounting change, the Enterprises’ provisions for losses related to
their guarantee business totaled $132 billion through the third quarter of 2011.

Figure 6: Enterprise Provisions for Losses on MBS Guarantees vs. Retained Mortgages 27




Multifamily
Like with their single-family business, the Enterprises participate in mortgages secured by
multifamily buildings, acquiring, holding, or securitizing them into MBS. As shown in Figure 5,
results from this business segment contributed a gain of $7 billion from 2008 through the end of
the third quarter of 2011.




27
   Information for Allowance for Loan Losses and Reserves for Guarantee Losses taken from annual and quarterly
filings (form 10K and form 10Q) from Fannie Mae and Freddie Mac between 2008 and 2011.


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            20
Investments
During the same time frame, investments contributed $4 billion in overall losses, as shown in
Figure 5. Figure 7 shows, however, that the Enterprises lost $83 billion on their investments in
2008, and that since that time annual gains have partially offset the 2008 results.

Figure 7: Investments Gains/(Losses) 2008 Through 3Q1128

                    $40
                                                         $38
                                                                                $31
                    $20
                                                                                                         $11
                     $0
     $ Billions




                   ($20)

                   ($40)

                   ($60)
                                                                             Overall Results: -$4 billion
                                  ($83)
                   ($80)

                  ($100)
                                  2008                   2009                  2010                  YTD 3Q11

Investment results are largely comprised of private-label MBS and derivative performance.

Private-Label MBS

From 2004 through 2007, as reflected in Figure 8, the Enterprises bought substantial quantities of
private-label MBS. Such securities typically offered higher yields than either their own such
securities or the mortgages they held in their investment portfolios. Further, in part, the
mortgages backing these securities often were issued to low- and moderate-income homebuyers,
whom the Enterprises had a legislative mission to serve.29


28
   Results from the Enterprises’ investments and capital markets activities include derivatives and agency securities
in addition to private-label securities.
29
  Federal Reserve Board Chairman Ben S. Bernanke said, “By borrowing at this preferential rate and purchasing
assets (including MBS) that pay returns considerably greater than the Treasury rate, the GSEs can enjoy profits of an
effectively unlimited scale.” Bernanke went on to say, “the GSE portfolio purchases may create benefits for home
purchase mortgages extended to lower-income households, to low- and moderate-income first-time homebuyers, and
to buyers of homes in lower-income neighborhoods.” Board of Governors of the Federal Reserve System, Statement


                     Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                21
Figure 8: New Acquisitions of Sub Prime and Other Private-Label Mortgage-Backed
          Securities, (by year of acquisition)30

                  $60


                  $50
                                                                   $51
     $ Billions




                  $40                                                                $42


                  $30

                                                $25
                  $20

                              $16
                  $10

                                                                                                          $0
                  $0
                         2004 & Prior          2005                2006             2007                2008




With the downturn in the overall housing market, the value
                                                                                 Payment Option ARM or
of private-label MBS held by the Enterprises plummeted as                        Option ARM
well. Freddie Mac noted in its financial statements for                          A special type of ARM that
2010, that the “decline has been particularly severe for                         enabled the borrower to choose
                                                                                 among various payments levels
subprime, option [Adjustable Rate Mortgages (ARMs)],
                                                                                 with each payment: a 40-, 30-,
and Alt-A and other loans” held in MBS.31 Freddie Mac                            or 15-year fully amortizing
cited high unemployment, a large inventory of seriously                          payment, an interest-only
delinquent mortgage loans and unsold homes, tight credit                         payment, or a negatively
conditions, and weak consumer confidence as contributing                         amortizing minimum payment.

to the poor performance of these securities. Further,

of Chairman Ben S. Bernanke (Mar. 6, 2007) (online at
www.federalreserve.gov/newsevents/speech/bernanke20070306a.htm).
30
 “Credit Statistics of Loan underlying Alt-A and Subprime Private-Label Mortgage-related Securities (including
Wraps)”, Fannie Mae Form 10-K, 2010, p124. and “Significant Modeled Attributes for Certain Non-Agency
Mortgage-Related Securities”, Freddie Mac Form 10-K 2010, p. 218.
31
  Freddie Mac, 2010 10-K Report, at 96 (online at www.freddiemac.com/investors/er/pdf/10k_022411.pdf)
(accessed Feb. 29, 2012).


                    Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                              22
subprime loans that back these securities have had significantly greater concentrations in states
that have experienced the greatest distress during the economic downturn, such as California,
Florida, Arizona, and Nevada. Loans in these states have experienced among the highest
delinquency rates and the credit losses associated with such loans have been among the highest
in the country.32 Nonetheless, steep declines in the value of the Enterprises’ private-label MBS
in 2008 have been offset by income from them and partial recovery of MBS prices since then.

Derivatives

As the Enterprises accumulated investments in mortgages
and MBS, they were exposed to significant risks affecting       Derivatives
the value of their mortgage-related assets. Like many           Securities used to hedge
                                                                interest rate or other risks
sophisticated investors, they entered into derivatives          related to holding a mortgage.
contracts to manage interest rate risk. Such hedging
activities are intended to moderate the possible financial      Hedging
impact from these risk factors. Derivatives function as a       The practice of taking an
form of risk management such that when the value of the         additional step, such as buying
underlying asset declines, the value of the derivative          or selling a derivative, to
                                                                reduce the risk of holding a
contract rises and vice versa. Changes in the value of these
                                                                certain investment, such as
derivatives holdings are generally expected to offset           MBS.
fluctuations in the value of the Enterprises’ portfolios of
mortgages and MBS. Thus, as MBS values have increased – and moderated the Enterprises’
private-label MBS losses – the values of derivative contracts have declined.

Other Losses
Losses attributable to the write down of low-income housing tax credits during the fourth quarter
of 2009 are included in “Other Losses” shown in Figure 5. Because the Enterprises currently are
not generating taxable income, the credits, which they had previously acquired, have no practical
present value to them. Therefore, they sought Treasury’s approval to sell their credits to entities
that have net operating income and thus potential tax liability that the credits can offset.
Treasury denied their requests. The write down of these credits for both Enterprises contributed
$8 billion of the $16 billion loss.




32
  Freddie Mac, 2010 10-K Report, at 96 (online at www.freddiemac.com/investors/er/pdf/10k_022411.pdf)
(accessed Feb. 29, 2012).


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            23
Accounting Adjustments
The Enterprises make changes to their accounting policies when they are required to do so. One
such change in 2010 required them to report on their balance sheets the amount of mortgages
outstanding that are included in MBS that they guaranteed. This resulted in a one-time $8 billion
loss for the Enterprises, as shown in Figure 5.

Dividends to Treasury
Through the third quarter of 2011, the Enterprises have paid Treasury $32 billion in dividends.
Of course, as discussed above, Treasury advanced the dividend payments to the Enterprises.




            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            24
PUTTING THE LOSSES IN PERSPECTIVE:
WINNERS AND LOSERS
As of the end of the last quarter prior to the conservatorships (i.e., June 30, 2008), the Enterprises
had $1.6 trillion in short- and long-term outstanding debt; $3.7 trillion worth of MBS guarantees;
and stockholders’ equity of only $54 billion. With mounting losses and without Treasury
funding, it is likely the Enterprises would have found themselves with insufficient funds to make
scheduled debt payments and satisfy MBS guarantee obligations.

Losers: Stockholders

According to the PSPAs, no dividends can be paid to preferred or common shareholders of the
Enterprises (with the exception of Treasury) without Treasury’s approval or until Treasury is
fully repaid. Additionally, Treasury received a warrant to purchase 80% of the Enterprises’
stock for a nominal amount. Both of these measures rendered the common shares of the
Enterprises virtually worthless. For example, Fannie Mae’s shares closed at $4.74 on the Friday
before conservatorship and as recently as of March 9, 2012, they traded for $0.32 per share on
the OTC Bulletin Board (Fannie Mae’s and Freddie Mac’s shares are no longer traded on the
New York Stock Exchange); similarly, Freddie Mac’s shares, which closed at $5.10 on the
Friday before conservatorship, have fallen to $0.326 per share as of March 9, 2012. Other
factors also have impaired the Enterprises’ share prices. Their share prices had deteriorated
substantially before the conservatorships, and, had the Enterprises been forced to liquidate,
common shareholders would not have received a return on their investment until all creditors and
senior classes of shareholders had been paid in full.33

In short, the PSPAs give priority in repayment to Treasury ahead of any other preferred or
common shareholders. Thus, the preferred and common shareholders of Fannie Mae and
Freddie Mac did not benefit by Treasury’s actions. They effectively lost their investments.

Winners: Holders of Bonds and Guaranteed MBS

Treasury’s investment effectively made “explicit” the federal government’s “implicit” guarantee
of the Enterprises’ debt. Further, by placing the Enterprises in conservatorship and committing
to making capital investments in them, FHFA and Treasury provided assurance that the
Enterprises would, in turn, be able to make contractually required payments to future creditors.


33
     12 U.S.C. § 4617(c).


              Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            25
Neither Enterprise publishes a comprehensive list of
                                                                                Creditors vs. Shareholders
creditors. However, foreign central banks, commercial                           Creditors, also called lenders,
banks, fund managers, insurance companies, state and local                      expect to earn interest that will
governments, corporate pensions, individuals, and                               be paid according to contractual
                                                                                terms.
nonprofit foundations invested in the Enterprises’ debt and
                                                                                Common shareholders are the
guaranteed MBS. For example, in the year before the
                                                                                owners of a company, can
conservatorships, Fannie Mae sold bonds to the following                        receive dividends if the company
categories of investors: foreign central banks (44%), fund                      declares them, and can sell their
managers (26%), commercial banks (18%), insurance                               shares to others.
companies (6%), state and local governments (4%), retail                        Preferred shareholders cannot
(2%), and corporate pensions (1%).34                                            vote on shareholder matters,
                                                                                but they receive preference
                                                                                over common shareholders if
More importantly, allowing the Enterprises to meet their                        the company becomes
debt and guarantee obligations enabled them to continue to                      insolvent and its assets are
support the secondary market. As the Congressional                              distributed.
Research Service has noted:

           A failure or default by Fannie [Mae] or Freddie [Mac] would have severely
           disrupted financial markets around the world. If the [Enterprises’] portfolios of
           mortgage loans and MBSs had to be liquidated, prices would plunge, the
           secondary market for mortgages would be decimated, and the supply of new
           mortgage credit might be severely restricted. These market disruptions would
           have negative impacts on the economy as a whole.35

Further, since September 2008, the private sector has almost entirely abandoned the secondary
mortgage market, and the Enterprises and Ginnie Mae have stepped up to fill the void. In 2010,
the Enterprises’ and Ginnie Mae’s guaranteed MBS comprised 96% of newly issued MBS.
Additionally, Treasury’s intervention has provided assurance to future creditors and MBS
investors that they, too, will get their money back if they transact business with the Enterprises.




34
  Fannie Mae, Review of Funding Activities for 2009, p. 2 (Dec. 2009). (Figures do not add to 100% because of
rounding.)
35
     Congressional Research Service, Fannie Mae and Freddie Mac in Conservatorship (Sept. 15, 2008).


              Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            26
OUTLOOK: FORECASTING FUTURE
GOVERNMENT PAYMENTS
From September 2008 through the end of 2011, Treasury invested $185 billion in the
Enterprises, and FHFA projects three scenarios for the future capital draws by both Fannie Mae
and Freddie Mac through the end of calendar year 2014.36 Under these projections, the amount
of the additional payments that Treasury would make to each Enterprise depends on the outlook
for home prices – e.g., whether prices continue to fall, if so, by how much and for how long –
and when and how strongly circumstances turn around so prices begin to increase. According to
the most recent projections, which FHFA released in October 2011, additional taxpayer
financing for the Enterprises ranges from $37 billion to as much as $128 billion through the end
of 2014.37 In other words, total Treasury support for the Enterprises is currently expected to
range from a low of $220 billion to a high of $311 billion.




36
  Federal Housing Finance Agency, FHFA Releases Projections Showing Range of Potential Draws for Fannie
Mae and Freddie Mac (online at www.fhfa.gov/webfiles/19409/Projections_102110.pdf) (accessed Feb. 29, 2012).
For this purpose, FHFA used three house price path projections with a “current baseline” in which the decline in
house prices hits bottom in the first quarter of 2012 and then prices rise by 15% through the end of 2014; a second
scenario in which near-term growth is stronger but prices end up at the same level as the baseline by the end of
2014; and a “deeper second recession” projection in which house prices bottom out in mid-2012 and then rise by
23%.
37
   However, the projections reported are not expected outcomes. They are modeled projections in response to “what
if” scenarios involving assumptions about Enterprise operations, loan performance, macroeconomic and financial
market conditions, and house prices. The projections do not define the full range of possible outcomes and actual
outcomes may be very different. This effort should be interpreted as an analysis of the sensitivity of future
Enterprise capital draws to possible house price paths.
FHFA provided the Enterprises with key assumptions for each scenario. The Enterprises used their respective
internal models to project their financial results based on the assumptions provided by FHFA. While this effort
achieves a degree of comparability between the Enterprises, it does not allow for actions that the Enterprises might
undertake in response to the economic conditions specified in the scenarios. Those Enterprise-specific business
changes could lead to results that differ from those presented in the projections.


            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            27
SCOPE AND METHODOLOGY
This is one in a series of audits, evaluations, and special reports reflecting FHFA-OIG’s ongoing
oversight and analysis of FHFA’s conservatorships of the Enterprises.

The bases of the financial analysis were the tables included in the Enterprises’ SEC filings,
FHFA’s Conservatorship Report of the Enterprises’ Financial Performance, and other publicly
available information. To gain an understanding of the issues discussed herein, FHFA-OIG
interviewed officials from the Office of the Financial Analysis, Modeling and Simulations,
FHFA, as well as the Office of the Chief Accountant, FHFA. FHFA-OIG also shared drafts of
the report with FHFA, Fannie Mae, and Freddie Mac executives.

This report was prepared under the authority of the Inspector General Act of 1978, as amended,
and in accordance with the Quality Standards for Inspection and Evaluation (January 2011),
which were promulgated by the Council of the Inspectors General on Integrity and Efficiency.
These standards require FHFA-OIG to plan and perform evaluations that obtain evidence
sufficient to provide reasonable bases for its findings and recommendations. FHFA-OIG
believes that the analysis and conclusions contained in this report meet these standards.

The scope of this report is from January 2008 through September 2011.

FHFA-OIG appreciates the efforts of FHFA and its staff in providing information and access to
necessary documents to accomplish this evaluation.




            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            28
APPENDIX
The Mechanics of Treasury Financial Support of the Enterprises

The Draw
With each quarter’s public filings, FHFA reviews each Enterprise’s financial report to determine
if its liabilities exceed its assets. This condition is called “stockholders’ deficit.” If there is a
stockholders’ deficit, FHFA requests money from Treasury – called the Draw ‒ to make up any
such deficit. Treasury, in turn, receives a similar increase in the stated value (called the
“liquidation preference”) of the senior preferred shares purchased from the Enterprises at the
inception of the conservatorships. Given this unique structure, Treasury is not lending money to
the Enterprises as much as it is investing in them.

Under HERA, if the obligations of an Enterprise exceed its assets for more than 60 days, FHFA
would appoint a receiver of an Enterprise.38 If Treasury had not been providing funding during
the conservatorships, the Enterprises, given their losses, would have entered receivership.

How the Draw is Calculated
          According to the terms of the PSPA between Treasury and each Enterprise, the
           Enterprises were required to each issue $1 billion in senior preferred stock without a
           corresponding cash payment from Treasury. This was called the “initial commitment
           fee.” Every time an Enterprise makes a Draw under the PSPA, the liquidation preference
           of the senior preferred stock increases by the same amount.
          Each quarter’s Draw is based on the stockholders’ deficit, if any, from the previous
           quarter.
          Up until the second quarter of 2011, the Draw was the stockholders’ deficit rounded up to
           the nearest $100 million and paid in the following quarter. Beginning with the payment
           in the third quarter of 2011, the Draw was rounded up to the nearest million dollars.




38
     12 U.S.C. § 4617(a)(4).


              Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            29
ADDITIONAL INFORMATION AND COPIES


For additional copies of this report:

         Call FHFA-OIG at: 202-730-0880

         Fax your request to: 202-318-0238

         Visit the FHFA-OIG website at: www.fhfaoig.gov



To report alleged fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

         Call our Hotline at: 1-800-793-7724

         Fax us the complaint directly to: 202-318-0358

         E-mail us at: oighotline@fhfa.gov

         Write to us at: FHFA Office of Inspector General
                         Attn: Office of Investigation – Hotline
                         400 Seventh Street, S.W.
                         Washington, DC 20024




            Federal Housing Finance Agency Office of Inspector General • WPR-2012-02 • May 24, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            30