As is well-known by now, one of the main reasons why the Fed’s hands are tied when it comes to the future of QE, is the dramatic drop in the US budget deficit which cuts down on the amount of monetizable gross issuance (read Treasurys) and for which a big reason is that the GSEs have shifted from net uses of government cash to net sources. So in what may be the best news for Bernanke, and/or his successor, we learn that according to a report written by the Federal Housing Finance Agency (FHFA) inspector general and reviewed by Reuters, “Fannie Mae and Freddie Mac are masking billions of dollars losses because of the level of delinquent home loans they carry.”
A financial entity, government-backed or otherwise, masking the true sad state of its balance sheet? Say it isn’t so. Alas, it is. Reuters has more:
The report, written by the inspector general for the Federal Housing Finance Agency and reviewed by Reuters, said the FHFA’s timeframe for mortgage finance companies Fannie and Freddie to have up to two years to recognize the cost of mortgages delinquent at least 180 days was “inordinately long.”
The change in the accounting treatment of these delinquent loans potentially could require Fannie and Freddie, which have rebounded to enormous profitability in the past two years as the housing market recovered, to “charge off billions of additional dollars related to loans,” the inspector general’s report stated.
For now the FHFA claims the losses are manageable…
The FHFA, which regulates Fannie Mae and Freddie Mac, said the two are on track to implement the new standards within the next two years, and in a letter sent to the inspector general said it views the potential losses “to be reasonable.”
The majority of Fannie Mae and Freddie Mac’s losses are a result of guaranteeing mortgages that defaulted during the housing crisis. Fannie and Freddie have reduced their funds reserved to cover potential losses on bad loans due to the strengthening housing sector and higher home prices.
The FHFA noted the new accounting methods would involve “changes in a significant policy,” and as a result require a lengthy implementation period. The regulator consulted with Fannie Mae and Freddie Mac and has allowed the mortgage companies until Jan. 1, 2015, to make all of the adjustments, which will be rolled out in stages. The inspector general’s office said in the report, dated Aug. 2, that Fannie and Freddie have not publicly disclosed the accounting changes.
…But the watchdog is not happy and is demanding a quicker implementation:
The report called on the FHFA to require Fannie and Freddie to conduct the changes at a faster pace, with the inspector general primarily concerned with loss estimates that are realized in Fannie and Freddie’s public financial statements.
Obviously using a flawed methodology to count cash flows is beneficial to the bottom line and as a result, both Fannie and Freddie posted massive profits in the past quarter, which also resulted in dividends flowing into the US Treasury. Which worked great at a time when the US in turn, was also masking its true sad budgetary state and was pushing to delay the debt ceiling fight, facilitated by the additional inbound cash from the GSEs.
However, now that we have “moved on”, the Taper is just around the horizon and the latest debt ceiling fight follows just after, and the Fed is actively thinking of permissive factor to untaper, especially once stocks plunge following the gradual reduction in monthly flow by the Fed and the realization that Bernanke may be pulling the training sheels, forcing the GSEs to “suddenly” admit their true state. What this will achieve is to change the direction in fund flows, and Fannie and Freddie will once again start to enjoy the benefit of tens of billions of inbound cash flows (i.e., a resumption of the old bailout regime) from the Treasury, which will be just what the Fed ordered, as this will have to be funded by more Treasury issuance, more Fed monetization, a return to the old $85 Bn/month in equity flow, more centrally-planned stock prices, and so on.
In other words, with the Taper already actively being priced in (although certainly not fully) for a catalyst on when the Untaper talk will start, look for the GSEs to return to their old sorry shape. That will be the warning light for when Fed will be actively contemplating how to boost monetizable deficit funding once more.