Fannie, Freddie rescue cost: $25 B?

by Frank James

There was already resistance on Capitol Hill to the Bush Administration's proposal that the Treasury Department and Federal Reserve increase their backstop role to Fannie Mae and Freddie Mac, witness last week's congressional hearings during which that reluctance among Republicans was palpable.

Thus the release today by the Congressional Budget Office of an estimate for the cost to taxpayers of the administration's proposal -- possibly $25 billion over fiscal years 2009 and 2010 -- raises the difficulty level the Bush team faces as it tries to win over enough resistant lawmakers to get legislation passed.

Among the elements of the Bush Administration's proposal is a request for Congress to extend authority to the Treasury Department so it can purchase Fannie Mae and Freddie Mac securities.

The CBO director's blog has a post which explains the assumptions Congress's numbers-crunching agency used to reach its estimate.

Here's a key snippet:

1. 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.

2. 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.

3. 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; CBO's 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. CBO's estimate of $25 billion in costs over the 2009-2010 period reflects a probability-weighted average of how large those injections might need to be, including zero as a potential outcome.