August isn't just the deadline for the Treasury's "extraordinary measures": it's also the month when these firms will likely request another multi-billion dollar cash infusion
A lot is written these days about the debt ceiling fight. Lots of articles also continue to bemoan the bailout of mortgage financiers Fannie Mae and Freddie Mac. Yet these two pet topics of economic and business commentators tend not to intersect. But they could in a few months. Every quarter, Fannie and Freddie go to the Treasury with their latest need for a cash infusion. Their next scheduled request will be in August -- the same month when the Treasury's "extraordinary measures" are set to dry up. Will Fannie and Freddie make the situation even more difficult for the Treasury if the debt ceiling isn't raised by that time?
First, it may be helpful to set the stage here. Generally, Congress routinely pushes the debt limit higher when U.S. borrowing grows and nears the cap it sets. But this time around, Republicans in Congress are concerned about the path of U.S. debt and are demanding spending cuts be made in conjunction with raising the limit.
A compromise is slow coming. In May, the U.S. debt ceiling would have been pierced, but to avoid that the Treasury took "extraordinary measures." These steps essentially consist of putting off internal obligations or debt issuance for the time being. But on August 2nd, those efforts won't be enough. If the debt ceiling isn't raised by that time, the U.S. would be in effective default, even if the Treasury prioritizes debt payments above others. It will be forced to defer or delay paying some obligations.
Meanwhile Fannie and Freddie continue to struggle. Their combined bailout is somewhere in the ballpark of $160 billion. Each quarter it grows, particularly as home prices decline. In May, to cover first quarter losses, Fannie requested $8.5 billion, while Freddie was able to get by without any more taxpayer dollars during the period. Presumably, one or both of these firms will request money again in August to cover second quarter losses.
The Treasury has absorbed these firms. As a result, the U.S. government has promised to make good on all of their debt. So a bond issued by Fannie is just as safe as one issued by the U.S. Treasury.
A Looming Problem?
If the debt ceiling isn't raised, then the Treasury will be put to the test on August 15th. That's when $25.6 billion in Treasury interest payments comes due. In order to avoid default, the Treasury will have to defer, delay, or dismiss other obligations at that time.
But the week prior, it will likely also learn that Fannie and/or Freddie need several billion dollars as well. Does this spell disaster?
According to a Treasury source, in this scenario, the U.S. government will still have some time to play with until the second quarter Fannie/Freddie cash infusion actually has to occur. Fannie/Freddie isn't paid until the end of the month after they request additional funds, explained the Treasury source. In this case, that would mean that the Treasury has until the end of September to worry about where it will find these additional billions of dollars.
That makes this potential problem a little less severe. The Treasury, rating agencies, and many commentators believe that the government will resolve this debt ceiling issue prior to the August 2nd deadline. But even if it isn't resolved by then, Washington will have nearly two more months to raise the limit before Fannie and Freddie will make Treasury's job even more difficult.
If no debt ceiling deal is struck by the end of September, however, then the Treasury will almost certainly prioritize this distribution. It's just as important that Fannie and Freddie continue to honor their debt as it is for the Treasury. A default on agency debt or agency mortgage-backed securities wouldn't be viewed much more favorably than a default on Treasuries. Of course, by that time, the rating agencies will be considering a U.S. downgrade and investors will likely already be demanding higher yields on Treasuries due to enhanced political risk. So by then, the Treasury would have bigger problems to worry about than what to cut back on to provide several billion dollars for Fannie Mae and Freddie Mac.
Image Credit:REUTERS/Jason Reed
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