July 22, 2008
CBO released a letter this morning that analyzes the Administration's July 14th proposal to provide temporary authority to the Secretary of the Treasury to purchase obligations and other securities issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The authority provided under this proposal would expire on December 31, 2009. (The Congress may consider a slightly modified version of the proposal, but it is unlikely that the modifications would have a significant effect on the estimated costs.)
- CBO estimates the expected federal budgetary cost (that is, taking into account the probability of various possible outcomes) from enacting this proposal would be $25 billion over fiscal years 2009 and 2010.
- Using historical and industry estimates of the expected losses on the different types of credit risk that the GSEs face in their current portfolios, CBO estimated the firms possible credit losses under thousands of possible future market conditions for housing prices. That analysis suggested that there was more than a 50 percent chance that the GSEs future losses would not exceed those already recognized, but there was almost a 5 percent chance that the added losses will total more than $100 billion. Given that distribution of possible future losses, CBO then evaluated how much assistance might need to be provided to the GSEs to allow them to continue operating in the capital markets.
- In particular, CBO assumed that the Secretary would want the GSEs to continue to have the ability to tap the capital markets after the temporary authority expired and that financial markets would provide such capital to the GSEs only if market participants perceived the GSEs to be sufficiently capitalized in terms of the value of their assets relative to their liabilities. Evaluating what financial markets would view as sufficiently capitalized requires judgment; CBOs approach is described in more detail in the letter. In other words, if the value of the GSEs assets was perceived to be insufficient relative to their liabilities, the Secretary would have to provide equity capital or subsidized debt to the GSEs before the temporary authority expired. CBOs estimate of $25 billion in costs over the 20092010 period reflects a probability-weighted average of how large those injections might need to be, including zero as a potential outcome.
CBOs estimate reflects the current budgetary treatment and existing scorekeeping conventions for federal credit assistance and equity purchases and does not necessarily measure the underlying change in the federal governments financial condition as a result of this legislation. On the one hand, the acquisition of financial assets like equities is recorded as an outlay in the budget even though such purchases may not change the governments underlying financial condition. On the other hand, even if enacting this legislation would not result in outlays over the near term, it might effectively strengthen the linkages between the GSEs and the federal government and thereby increase the governments underlying exposure to the risks associated with the GSEs activities.
A final point to note is that a strong argument can be made that if the Treasury used the proposed authority, the GSEs operations should be incorporated directly into the federal budget. That is, the proposal, especially to the extent it would result in any government acquisition of an equity stake in the GSEs, raises a significant budgetary question. Currently, data on the GSEs are reported along with federal budget information each year, but the activity of those entities is not encompassed within the budget. That treatment could change if the federal governments financial stake or control changes in a significant way. For the purposes of this cost estimate, CBO did not incorporate any change in the underlying budgetary treatment of the GSEs, in part because the proposed authority would be temporary; if it is not used, the relationship between the GSEs and the federal government would presumably return to one consistent with current budgetary treatment after the temporary authority expires.