Paulson Gives Fannie and Freddie a Tax Break Too

I bet every on-the-ropes corporate borrower would like to get the tax bennie that the Treasury extended to the GSEs today, namely, giving them what amounts to a private waiver for their net operating loss carryforwards.

As much as one can argue that the Frannie and Freddie salvage operation is a unique situation, the notion that the Treasury is changing well-established tax principles to favor the GSEs is disturbing. Mind you, this is also after the plan diluted rather than wiped out common stockholders, so if the GSEs recover, this move would benefit the old shareholders. What else are the powers that be doing that either hasn’t come to light or won’t make its way into the press?


Wouldn’t it be nice if the Internal Revenue Service issued a new tax rule that applied just to your company to help it retain all the net-operating losses it could? In that way, the NOLs could be used over the next 20 years to offset income, and reduce the company’s tax bill.

That’s what Treasury Secretary Henry Paulson did for Fannie Mae and Freddie Mac on Monday, when he had the IRS issue Notice 2008-76, which essentially allows the two government-sponsored enterprises to retain all of their NOLs, despite a change of control of ownership, tax expert Robert Willens told

Under the tax code — specifically Section 382 — NOLs are severely limited when there is a change of control… The NOLs for Fannie and Freddie are substantial. Over the last four quarters, Fannie and Freddie recorded about $14 billion in aggregate losses.

In essence, Paulson changed tax law so that the two lenders aren’t paying more in taxes to the government as a result of that same government becoming their controlling investor. When the government structured its bailout of the two mortgage lending giants, it seized control of Fannie and Freddie by buying up $1 billion worth of senior preferred stock in each GSE. The plan also stipulates that Fannie and Freddie will pay a 10 percent annual dividend on the preferred stock owned by the government; and no other dividend can be paid out without the permission of the Treasury Department.

If the Treasury Department were simply another company, such a takeover would constitute a change of control under the tax code. But the new ruling creates a big exception for the two mortgage lenders. And while the IRS ruling was issued without any basis in law, says Willens, the NOL provision of the bailout was done “very effectively.” He explains that the new rule eliminates the “testing dates” that normally would have applied to Fannie and Freddie, or any other company, in the event of a takeover….

With Fannie and Freddie’s market caps at all time lows, the government would have been able to claim only a fraction of the original NOLs, opines Willens. However, by eliminating the testing date, the IRS also eliminates the question of whether the bailout constituted a change-of-control under the tax law. “It becomes a moot point,” says Willens…

“I am not saying that the IRS ruling is a good thing, or a bad thing, it is just unusual,” asserts Willens. “Then again, this is a very unusual situation.”

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  1. doc holiday

    Re: ” IRS issue Notice 2008-76″

    I still thing Al “Hank Paulson” Capone is playing on very thin ice here, as he allows Treasury to set up shop on wall street, and now make up tax laws — this is seriously retarded in every respect and as usual, where is the lowest rated (in American history) congress or senate in this matter?? My only guess, remains that this group of crooks is very busy with lobby groups counting the latest loot!

  2. Anonymous

    More on those NOLs from a Bloomberg article:


    Fannie counted $20.6 billion in so-called deferred tax credits toward its $47 billion of regulatory capital as of June 30, according to company disclosures. Freddie applied $18.4 billion in deferred-tax assets toward its $37.1 billion in regulatory capital in the second quarter.

    Fannie and Freddie have posted four straight quarterly net losses totaling a combined $14.9 billion and have said they anticipate more. The tax credits don’t have any value unless the companies are generating profit.

    “That’s not even real money,” [Senator] Shelby said.


    Well, I’ve got news for you, Senator Shelby. Those peachback paper “dollars” that you’re counting in? That’s not real money either, pal.

  3. Anonymous

    So here’s my question. Can Exxon buy up all the Freddie stock, take it over and use the loss carry
    forward (deferred tax assets) against earnings? If they can, the shares might be valuable at 99 cents.

  4. Carlomagno

    If Paulson hadn't done this, F&F would have breached their regulatory capital requirements. Now, I find it sick that deferred tax assets can be counted to meet regulatory capital requirements in the first place (this is comparable to the "regulatory goodwill" accounting shenanigans of the S&L era) and I'm not suggesting that Paulson's decision is to be commended, but I think this explains that.

  5. Anonymous

    “In essence, Paulson changed tax law so that the two lenders aren’t paying more in taxes to the government as a result of that same government becoming their controlling

    Isn’t this unconstitutional? God, I am so naive. Who is left to challenge it?

  6. Nemo

    Aren’t the NOLs an asset on the balance sheet?

    If so, cutting them now, while the firms almost certainly face losses, would just increase the accounting deficit according to GAAP… And therefore the cash that Treasury must inject today.

    Under the circumstances, this seems like a very reasonable move…

  7. Anonymous

    That’s funny, last week everyone was saying that the deferred tax asset was worthless. Treasury’s action only ensures that its value doesn’t change as a result of conservatorship. If it was worhtless before, it is still worthless now. But Treasury is sure going to some effort to protect the value of a worthless asset, isn’t it? And that’s after using the worthlessness of the asset as part of the justification for the takeover.

    Someone above suggests that this tax regulation was unconstitional. Guess what? The taking of the GSE’s from their shareholders without compensation was unconstitutional, too.

    LEH may be next, watch out capitalists! You thought only in Russia and Venezuela was it ok to take private property for the public’s benefit without compensation. Wrong!

  8. Anonymous

    September 9, 2008

    Here’s the deal boys and girls:
    1. The largest financial institution in the USA is now being run by politicians.
    2. There are no rules that apply to politicians.
    3. There will be no rules, whatsoever, applied to the financial conduct of the former Fannie/Freddie other than the “rules” of political expediency.

    Earl L. Crockett
    Santa Cruz, CA

  9. Anonymous

    no, company a cannot buy company b and use b’s existing nol to offset its income. you cannot “come to” the (someone else’s) loss.

  10. Kady

    Well, now that the feds has changed the rule about NOLs carrying despite a change of control, who says that some company can't buy F/F's existing NOLs?

    Also, can't find the source, but I thought the trigger for the whole bailout this wkend was the discovery of deferred tax credits counting toward F/F's regulatory capital. IOW, the Feds concluded that once the deferred tax credits were removed, F/F had in fact breached their capital requirements –> conservatorship.

    Also, in terms of constitutionality, where does the Fed get the pwr to commit a whole lot of American tax $ to this bailout? Shouldn't this have had to go through Congress. I'm thinking that this must fall under emergency appropriations but can anyone shed further light?

  11. ruetheday

    I’m sure that in 28 days, he’ll be issuing an edict to the NYSE to suspend their rules on delisting for these two stocks.

  12. Anonymous

    paulson only took 80% of the companies because he’s an honorable guy.

    he knows that the fix was in on this one. members of his own government were running around the financial markets all year, trying to freak out central banks and start a run on the bank. i have high conviction that folks in government were leaking to members of the investment community about what was going on behind the scenes. it was the same cast of characters who tried to take down fannie with blatant lies that were leaked to the markets via the press in 2004/2005.

    rather than give in to the true believers who wanted to use the credit crisis to shut down the companies, paulson structured a transaction that solidified the companies, gave existing shareholders a chance to see this credit/political cycle through to the other side, and kept the ideologues at bay.

    lockhart and demarco can now slug it out with barney frank and chris dodd next year after paulson’s left town. that should be interesting to watch, esp since the dems will have 55 votes or more in the senate, even if mccain wins.

    the two numbers that are the most important to this process – the cum loss estimates MS used to justify the action – ought to be the matter of public record.

    my analysis, based on vintage curves from the 06/07 books of business were that freddie was heading towards 20-25B of losses; fannie was probably $40-50B.

    both were easily absorb-able given the revenue bases and existing loan loss reserves, not to mention the fact that the timing of the cash outflows was over a 5-7 year period.

    this whole thing stinks – and not for the reasons that are being trumpeted in the media.

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