Fannie and Freddie at risk, Treasury says

Discussion in 'Economics' started by wincorp, Jun 27, 2006.

  1. wincorp


    Fannie and Freddie at risk, Treasury says

    Fannie and Freddie at risk, Treasury says

    Dow Jones Newswire via The Associated Press

    WASHINGTON — The massive portfolios of government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac could become insolvent in a period of "significant interest-rate movement," U.S. Assistant Treasury Secretary Emil Henry said Monday.

    "Unless the portfolios are hedged properly, in a period of significant interest-rate movement, there is a risk to the GSEs that their assets and liabilities will ... become broadly mismatched, which can lead to insolvency," Henry said in a speech prepared for delivery to the Housing Policy Council of the Financial Services Roundtable.

    Henry likened the potential for GSE problems to the savings-and-loan crisis of the 1980s.

    To hedge against interest-rate movements, the GSEs must anticipate borrower behavior and deploy risk-management strategies, much like other large companies invested in mortgages, he said.

    But Henry said the massive size of the GSE portfolios — at more than $1.5 trillion — combined with a lack of traditional market discipline and a level of interconnectivity in the financial markets means the GSEs pose a unique systemic risk.

    "Aggregating each of these attributes under a single entity that also carries with it the broad misperception of a government backstop or guarantee creates a 'perfect storm' scenario," Henry said.

    Henry noted that the markets continue to hold the "false belief" that the U.S. government guarantees GSE debt, which has led to preferential funding rates and the expansion of GSE portfolios.

    "Simply stated, our financial markets would be safer if these assets and associated risks were broadly redistributed," Henry said.

    Henry noted that the GSEs say they are hedging against risks from an unexpected or sharp change in interest rates. In response, Henry pointed to a recent report from the Office of Federal Housing Enterprise Oversight that criticized GSE hedging practices.

    If GSE hedging models failed to anticipate an interest-rate shock, "the results would be without precedent," he said.

    Commercial banks and other creditors would experience direct losses as GSE debt obligations lost value, or there was a real or perceived inability of a GSE to meet its debt or mortgage-backed security obligations.
  2. I believe this is somewhat on topic. Ignoring larger economic effects, what is the actual meaning to a home owner if his specific mortgage holder goes bankrupt?
  3. Fed Governor Poole made a similar cryptic speech about the risks of Fannie Mae back in either 2002 or 2003. Sort of a matter of fact doomsday speech. Was kind of chilling actually.
  4. As a homeowner I interested in the answer to this as well.
  5. I very much doubt that anything happens for the home owner. The agent that services the loan may change and this could have some small impact (like how late a late payment starts becoming a problem or how escrow is handled) Edit: Prepayment (if allowed) is the owner's option and mortgages are not "callable." They are also an asset whose value depends on the coupon rate, the LTV, the borrowers FICO scores (if known), etc, and that's what they'll sell for. If the GSEs collapse, it'll have an effect on the mortgage markets (at least in the short run, because of their size), so your house value may implode when buyers are unable to obtain financing.
  6. What it means is that that beautiful 3BD 3BR pool home he bought recently is worth a hell of a lot less than he paid for it, and he's next in line in bankruptcy court.
  7. These two companies were originially intended to securitize mortgages and lay them off. Not a very exciting business, but a safe one. Then they started pushing the envelope and expanding their own assets. Of course, the reason they did it was to create larger profits and hence larger compensation for the political hacks that were delegated to run them. Their increased size and lobbying clout let them buy protection from congress against regulatory oversight, and they began expanding at an increasing rate, all the while playing the corrupt Wall Street game of "better than expected" and gargantuan options awards.

    They have operated a business that is actually much riskier than a commercial bank at capital/asset ratios that are far smaller than any bank regulator would tolerate. We are lucky their accounting scandals didn't evolve into a massive financial meltdown.

    It is incumbent on the government to crack down hard on them now, or else we will face the same situation or worse a few years down the road. They should be forced to shrink drastically their balance sheets, the former FNM management should be forced to disgorge their options and should be prosecuted, and the Congress should pass a law stating clearly that the government is not responsible for their debt or losses. The housing finance market is certainly robust enough to handle the minimal shock. Bottom line, this near disaster is proof positive of the principle that government should stay out of private business. When it is ignored, we get corruption, market dislocations and taxpayer-financed moral hazard.
  8. Why would the home owner be entitled to compensation from the owner of the mortgage in the event of bankruptcy?

    House prices would only be affected by a nationwide crisis in the mortgage markets. I guess you could try to prove a link to "gross operational negligence" at the GSEs, but if they bankrupt, they're more than insolvent. You could try to sue the federal government (not), for not providing a bigger, explicit subsidy. Other than explicit statements re lead paint, leaky basements etc, no one's guaranteeing the price tag for a house.
  9. Fannie originally held them (1938, 1968 spin off). Freddie started pooling and selling from the get-go (1970)

    ... Of course, the reason they did it was to create larger profits ....

    ....and the Congress should pass a law stating clearly that the government is not responsible for their debt or losses.

    Good point - if you have a free put on your debt, you don't ever pay for growing in size. You'd have to be crazy not to grow your retained portfolio like mad. Shareholders could probably sue you for not looking out for their interests.

    GSE debt already is required to come with a statement that it is not insured by the Federal government, but no one seems to believe they'll be left to dangle. The GSE's will argue that they are able to hedge far better than anyone else, and that's why their debt trades only 10-50bps above Treasuries.
  10. Ha, your missing my point. The homeowner is going to be the next person to file bankruptcy. If the mortgage holder is bankrupt its because the borrowers can't pay. The borrowers can't pay because their ARM loan has adjusted upward. Nobody else wants or can afford the house either. Borrower defaults. Lender sues for a deficiency judgment. Borrower seeks protection from bankruptcy court.

    Bottom line is if your mortgage holder goes bankrupt, then things are pretty friggin' bad out there.
    #10     Jun 28, 2006