Long criticized for their excessive leverage, the balance sheets at Fannie Mae and Freddie Mac will explode this quarter as they account for mortgage loans worth trillions.
The government-sponsored enterprises are being hit hard by a rule released last summer by the Financial Accounting Standards Board (FASB) requiring companies to bring securitizations onto their balance sheets.
For Fannie, that means bringing $2.8 trillion of mortgage loans onto its books; it had $890.3 billion of assets at Sept. 30. Freddie held $866.6 billion of assets at Sept. 30 and plans to transfer $1.8 trillion of mortgage loans to comply with the FASB rule.
Fannie and Freddie are unlikely to raise more capital to account for their expanded balance sheets since the Treasury Department has committed itself to infuse as much as is necessary into the GSEs to keep their net worth positive. But with the accounting changes potentially tripling or quadrupling Fannie's and Freddie's balance sheets, important questions arise about how they will emerge from conservatorship.
"Do you think the federal government can move to a post-conservatorship world with Fannie and Freddie with those kinds of balance sheets?" asked Joe Murin, the managing director of the Collingwood Group and a former chief executive of Ginnie Mae. "It's a big deal for us as taxpayers to look at the leverage here. It almost guarantees the federal government is going to be involved in this for many years."
Reckoning with the future of Fannie and Freddie is largely seen as a task for another day. The more immediate question is whether the FASB rule will send Fannie and Freddie into negative net worth and back to the Treasury Department for funding.
In a controversial Christmas Eve announcement, the Treasury effectively lifted any cap on how much Fannie and Freddie could borrow from their government credit lines.
In its third-quarter report, Freddie acknowledged the accounting change could "have a significant negative impact on our net worth and could result in additional draws" from the Treasury. Fannie said the change "will affect our net worth," but its report did not address whether it would require further borrowing from the Treasury.
Through the third quarter, Fannie had borrowed $60 billion from the Treasury and Freddie had tapped it for $51 billion. Analysts said it is impossible to guess how much more the GSEs may need to borrow.
"There certainly will be some impact on implementation," said Brian Harris, an analyst at Moody's Investors Service. "If you want to quantify it, we can't do that."
But it is almost certain that regulators will not require the companies to raise additional capital privately.
The Federal Housing Finance Agency (FHFA), which acts as the conservator for Fannie and Freddie, effectively abandoned minimum capital rules after the companies were seized by the government in September 2008.
Fannie said it was $91.7 billion below its minimum capital level by the end of the third quarter, and Freddie said it was $43.8 billion short.
Jim Vogel, the head of fixed-income research at First Horizon National Corp.'s First Financial Capital Markets, cautioned that, though the sudden expansion of Fannie and Freddie's balance sheets — especially in light of their weak capital positions — may be unnerving, there are no surprises here because the GSEs regularly report on their holdings.
"The character of Fannie and Freddie's off-balance-sheet assets have always been well-known and discussed," he said. "They were never shifted off the balance sheet as a move to achieve a regulatory or economic end. They have something of a different character than other private players."
Though capital deficits at a company with a multitrillion-dollar balance sheet would make a banking regulator swoon, the (FHFA) has no plan to require more capital as long as the Treasury stands ready to fill the holes.
House Financial Services Committee Chairman Barney Frank said this month that addressing the fate of Fannie and Freddie is a top priority for this year. But the bigger balance sheets have important implications if policymakers decide to nationalize or privatize the GSEs.
"Whenever you get the new GSEs up and running, especially if there's a private component, it will likely mean you'll need even more capital," said Bose George, an analyst at KBW's Keefe Bruyette & Woods.
On the flip side, nationalizing the GSEs has been a tough sell because it would bring their full cost onto the federal budget. The larger balance sheets merely compound the budget-deficit problem.
"It's suicide for Congress to even think of that," said Collingwood's Murin.
Fannie and Freddie are not alone in grappling with the fallout from FASB's rule.
The banking and thrift regulators said Thursday that financial institutions could take four quarters to adjust to the new accounting standards.
Still, KBW's George said bank balance sheets are unlikely to expand so dramatically because Fannie and Freddie have long dominated the securitization markets.
"Even for the largest banks, it seems unlikely to be on this scale," he said.