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The writer is chair and chief executive of Stifel Financial Corporation
A move by President Donald Trump to create a sovereign wealth fund for the US is a significant initiative that could bolster the financial stability of the nation.
One effective way to accomplish this goal is to combine it with the long-standing objective of privatising Fannie Mae and Freddie Mac, the government-sponsored home loan agencies.
Historically, sovereign wealth funds are established by countries that enjoy substantial trade surpluses. However, the US is currently facing both trade and budget deficits, presenting a challenge for such an entity to raise initial funds.
A promising solution lies in transferring the Treasury’s ownership of Fannie Mae and Freddie Mac into a newly created sovereign wealth fund before their privatisation. This approach would not only provide funding but also support the efficient privatisation of these key financial institutions.
Fannie Mae and Freddie Mac buy mortgages from lenders and primarily package them into mortgage-backed securities (and also hold a small percentage of these assets in their own portfolios). Effectively, they guarantee around half of the US mortgage market.
The Trump administration is actively exploring pathways to privatise the agencies, which were placed under government conservatorship after their bailout during the financial crisis of 2007-08. The government also supports roughly 20 per cent of the mortgage market through Ginnie Mae corporation, which is a wholly owned part of the Department of Housing and Urban Development. However, this programme will not be impacted by any privatisation of Fannie Mae and Freddie Mac.
Two major obstacles remain to such a privatisation. First, the current capital levels at Fannie Mae and Freddie Mac yield a low return on equity — a key measure of profitability — of 8-9 per cent which deters private investment. Second, there are concerns within the financial markets that privatising them could widen the interest rate spreads of agency mortgage-backed securities over benchmark debt if government support is perceived to diminish.
But by integrating the agencies into a sovereign wealth fund, the government would retain majority ownership, providing crucial market reassurance about continued government backing. This would not only stabilise investor confidence but also enable the agencies to run as utiliites with a low double digit ROEs which would require minimal increases in guarantee fees and mortgage rates.
The sovereign wealth fund could periodically issue shares in the agencies to attract value investors seeking stable, utility-like returns, while also holding shares to collect dividends during periods of lower demand.
Currently, Fannie Mae and Freddie Mac together hold nearly $155bn in equity and are building capital at a rate of around $30bn a year. Fannie Mae is on track to meet its minimum capital requirement of $111bn by 2026, while Freddie Mac is expected to reach its $95bn target by 2027. This is based on the statutory 2.5 per cent minimum capital requirement.
The government-sponsored agencies are currently also required to maintain incremental buffers that take Fannie Mae’s minimum capital requirement to $190bn and Freddie Mac’s to $146bn, which would take multiple years to reach, if the buffers are not reduced.
However, Keefe, Bruyette & Woods research analyst Bose George reminds us that although the agencies are currently restricted from accessing capital until they meet these minimums, they can continue to grow organically, enhancing the book value of the sovereign wealth fund in the process.
If this strategy is executed effectively, the sovereign wealth fund could hold Fannie Mae and Freddie Mac shares valued at more than $200bn by the end of 2026, assuming shares trade at book value. This portfolio could generate approximately $30bn in annual income, which can largely be distributed as dividends once the agencies are adequately capitalised, which can then be used by sovereign wealth fund for reinvestment. With a projected high single-digit investment return, this combination could pave the way for a $1tn sovereign wealth fund by 2040.
Bold initiatives require bold and strategic execution. By merging the goals of establishing a sovereign wealth fund and privatising Fannie Mae and Freddie Mac, the Trump administration has an opportunity to address significant economic challenges while laying the groundwork for long-term financial stability. This strategic move could ultimately benefit both the US economy and its citizens for generations to come.
Thomas Michaud, chief executive of Keefe, Bruyette & Woods contributed to this article.
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