Should the economy take a turn for the worst, Fannie Mae and Freddie Mac would draw between $34.8 and $99.6 billion from the U.S. Treasury under the Senior Preferred Stock Purchase Agreements (PSPAs), according to the results of the 2017 Dodd-Frank Act Severely Adverse Scenario Stress Tests released today by the Federal Housing Finance Agency. The actual total would depend on the treatment of the Enterprises’ deferred tax assets, the FHFA reported.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, Fannie Mae and Freddie Mac—as well as other federally regulated financial institutions—are required to conduct stress tests on an annual basis. These tests ensure the institutions have the necessary capital to absorb any losses should the economy enter a recession.
Tests under the Severely Adverse scenario, according to the FHFA, are “based upon a severe global recession which is accompanied by a period of elevated stress in corporate financial and commercial real estate markets. It includes large reductions in asset prices, significant widening of corporate bond spreads, and strained market liquidity conditions. The scenario is not a forecast, but instead is a hypothetical future economic environment designed to assess the strength of the Enterprises and other financial institutions and their resilience to unfavorable market conditions.”
Details of the Severely Adverse scenario used in today's testing, according to the FHFA, were: "U.S. real GDP begins to decline immediately and reaches a trough in the second quarter of 2018 after a decline of 6.50 percent from the pre-recession peak. The rate of unemployment increases from 4.7 percent at the beginning of the planning horizon to a peak of 10.0 percent in the third quarter of 2018. The annualized consumer price inflation rate initially declines to about 1.25 percent by the second quarter of 2017 and then rises to approximately 1.75 percent by the middle of 2018."
At the close of 2016, the two government-sponsored enterprises had drawn a total of $187.5 billion from the Treasury as part of the PSPAs. Just over $258 billion of the funding commitment remained at the time.
If the worst-case scenario economic downturn occurred—and Enterprises made the forecasted draws, the FHFA estimates that funding commitment would then value around $158.4 billion, taking into account deferred tax assets.
Today marks the fourth time the Enterprises have undergone the testing. View the full results at FHFA.gov.