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  • July 15, 2008 01:31 PM EDT by Elizabeth MacDonald

    Fannie and Freddie on the Brink

    As shares in Freddie Mac (FRE) and Fannie Mae (FNM) rocket up and down faster than a whale on a bungee cord, US Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have taken to Capitol Hill to testify about the government's rescue of these two out of control mortgage finance giants.

    Former US Treasury Secretary John Snow got it right last week when he said that Fannie Mae and Freddie Mac have relied on leverage to fund their businesses in the same fashion as a hedge fund.

    And now, after Fannie and Freddie have blown out their economic circuits, Americans get to own a piece of these shoddy businesses whether they wanted to or not, companies who provide Exhibit A of the worst form of government entrepreneurial senility, as one of my readers wrote me.

    It's a strange and disturbing thing to behold the delightful bit of throat clearing from Congress finger-wagging Wall Street for not setting aside adequate capital against their exposures and for poor risk management (all true), despite the fact that elected officials let these two DC-based hot air balloons inflate the housing bubble even more and grow out of control right under their noses.

    Given that teetering atop their painfully razor thin capital cushions is a book of business that is nearly half the size of the US gross domestic product. The wheels started coming off these two careening freight trains a long time ago.

    What is going on should be as clear as a country creek to you. Elected officials still refuse to put the guard rails up around these two businesses in the form of statutory limits on their colossal $5.3 tn book of business.

    Fear is now rampant that the US government must now swallow these two obesities, causing the US dollar to plunge in anticipation of the need to mint more dollars, creating more inflation. At minimum, some kind of taxpayer funding will be a backstop. Since when did you, the taxpayer, agree to this mess (not to mention the $99 tn in unfunded liabilities at Social Security and Medicare, according to Fed stats).

    This mess should tell you that Congress has no regard whatsoever for taxpayers, and these developments are proof positive that Congress has no more sense than a flock of geese. Elected officials should be as tight as a miser's fist when it comes to spending your hard-earned tax dollars but they clearly do not care about such inconveniences when it comes to using your money to dole out pork to get re-elected. Instead of fixing the problems, Congress wastes time fingerpointing, as debate becomes target practice.

    Because as losses mount at these two goliaths--$11 bn in the last three quarters and counting--the Treasury will simply mint more debt and use that resulting capital to inject more liquidity into them, despite their history of accounting misdeeds, losses and misstatements that prove that these two companies do not know what they are doing.

    Fannie and Freddie buy mortgages, providing funds for banks to use to keep lending more loans. They also keep some mortgages on their books and repackage the majority into securities now sitting as potential landfill in central banks, pension funds and all sorts of investment portfolios around the world.

    Those securities are backed by zombie loans given by banks such as Countrywide Financial (CFC), which pointed its conveyor belt of bad loans at Fannie, Freddie and Wall Street to repackage as securities.

    Together, Fannie and Freddie own or back about $5.3 tn of U.S. home mortgages--nearly half of all mortgages outstanding. They now touch 80% of new loans (emphasis on new), and support about 80% of mortgage-backed securitizations, as Wall Street isn't doing much of these deals any more because its recycling machine for these cut and paste jobs has had sand thrown in its gears.

    Which is why a downturn in shares in both Fannie and Freddie, down some 90% from a year ago, coupled with the plunging value of their mortgage debt sitting on their balance sheets, couldn't come at a worse time.

    The government hopes to rely on them with its housing rescue plan to securitize even larger jumbo loans for the first time in the history of Fannie and Freddie to keep the US housing market above water.

    And because banks here and around the world have invested in their securities, any plunge in the value of the debt from Fannie and Freddie could hurt their books as well, forcing them to raise even more capital. 

    The problem is, Fannie and Freddie combined have a net worth of $54 bn, despite the $81 bn you see in core capital (a pro forma figure that doesn't include losses shoved into a line item called other comprehensive income).

    Again, teetering atop that is their $5.3 tn book of business.

    The two have a total of about $260 bn of subprime and Alt-A loan securitizations (the no-income, no-asset stuff somewhere between sub and prime loans). Another $3.3 tn in securitizations sit in off balance sheet vehicles, Lehman Bros says. Again those sums dwarf their capital positions.

    Freddie has $156.8 bn in level three assets, those illiquid securities it can't sell because no one wants them. That's a fifth of its fair valued assets. Fannie has $56.1 bn in level three assets, or about a seventh of its fair valued assets. Again those sums dwarf their capital positions.

    Fannie has $804 bn in total liabilities, Freddie has $786.8 bn in total liabilities. Their guaranteed liabilities were 29 times their net worth at the end of the first quarter.

    JPMorgan Chase (JPM) or Bank of America (BAC), for example, have almost as much bank-level capital as these two "combined supporting one fifth of the commitments," says the research website The Institutional Risk Analyst, published by Lord, Whalen LLC.

    So the fear is that, as mortgages belly flop right and left and an increasing number of homes go into foreclosure, the two are insolvent. Former Fed official William Poole has said as much of Freddie Mac, and the government would at worst have to take onto its balance sheet their $5.3 tn, blowing out the US books. Or again backstop it with some kind of taxpayer funding.

    The government's plan is to now let these two giants borrow much more out of their credit pipelines into the US Treasury, now at $2.25 bn each. So far the two have not accessed these pipelines. They also now have access to the Fed's discount window at a cheap 2.25% rate to get untold sums of liquidity injections. But the question is whether they can potentially use as collateral for those loans securities they can mint themselves backed by mortgages taken out by, we can only hope and pray, upstanding borrowers.

    Because as losses mount at these two goliaths--$11 bn in the last three quarters and counting-the US Treasury will simply mint more debt and use that capital raise to inject more liquidity into them.

    The markets are behaving quite rationally in response to the government's weekend rescue plan by bidding down the shares of Fannie and Freddie and by sending up the prices of their debt, the idea being that equity shareholders may get zeroed out here while the bonds are protected.

    Fannie Mae was born in 1938 as part of FDR's New Deal to get the country out of the Great Depression and provide home ownership. Back then millions of Americans were struggling to buy homes, and also faced foreclosures, as banks weren't lending and mortgage money had dried up.  

    For years Fannie sat on the government's books, helping to expand the real estate industry. In 1968, the LBJ administration said, get this thing off of the government books, so Fannie Mae became a publicly traded company.

    When the savings-and-loan industry wanted its own mortgage financing creature to play with beginning in 1968, Congress obliged and in 1970 Freddie Mac was born. 

    So up cropped two quasi-socialist mortgage finance giants.

    But Congress failed in a really dramatic way to rein them in through the decades.

    It used to be that when mortgages were sold to these two mortgage giants, the same lender who did the selling to Fannie and Freddie would hold some of the risk of these loans repackaged as securities on their balance sheet.

    But banks figured out a way to offload that risk via derivatives and shot these risky loans into the ether from here to the Arctic circle. That broke the bond between the overseer, meaning the lender, and the borrower. Why care about monitoring a borrower who has no skin in the game with a zero down mortgage when you've entirely offloaded that loan as a security?

    Through the decades, Congress did little to dissuade taxpayers and investors from the notion that Fannie and Freddie were backed by the full faith and credit of the U.S. government, when they are not. Again, they both have credit pipelines into the US Treasury of $2.25 bn each, and that's where the backing was supposed to end.  

    For years now the government knew these two posed a problem. A 2001 study by the Government Accountability Office said that these two might warrant only an "A" rating as private stand alone entities, but likely near junk status, based on their leverage, says the research firm The Institutional Risk Analyst is published by Lord, Whalen.

    The research firm also notes a prescient dialogue between former Fed chairman Alan Greenspan and then-Senate Banking Committee Chairman Richard Shelby (R-AL).

    Greenspan, who had been warning about these two for years, said the two mortgage finance giants "could not be supervised using the safety and soundness rules employed by regulators with banks," due to "woefully inadequate capital compared to commercial banks."

    And yet, Fannie and Freddie lumbered along, becoming to the US economy what off-balance sheet entities were to companies "like Enron, Parmalat and Citigroup (C)," says The Institutional Risk Analyst. "Bloated far beyond their historical role of merely acting as conduits for securitization of residential mortgages, Freddie and Fannie [are] at much higher leverage ratios than any bank or hedge fund," it adds.

    The research outfit says it sees a federal takeover of the two "as not only inevitable, but as an avenue to rationalize and shrink these institutions, and thereby remove a costly distraction from the Washington political scene."  

    Finally, listen to what Sen. Jim Bunning (R-KY) had to say at the hearing today--though his words were hot enough to melt silver, and the thing is, many market watchers say he's right--and right to be angry. Since when did you the taxpayer agree to this mess that was created?:

    "Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem."

    "When I picked up my newspaper yesterday, I thought I woke up in France. But no, it turns out socialism is alive and well in America. The Treasury Secretary is asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed's purchase of Bear Stearns' assets was amateur socialism compared to this." (see blogs, "New Details from Fed Minutes on Bear Stearns Rescue," "The Bear Trap," and "The Brinkmanship at Bear Stearns").

    "And for this unprecedented intervention in the markets what assurances do we get that it will not happen again? None. We are in the process of passing a stronger regulator for the G.S.E.s [government-sponsored enterprises], and that is important, but it allows them to continue in the current form."

    "If they really do fail, should we let them go back to what they were doing before?"

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John Mason

Hey; not to worry! It's all good, just ask your favorite representative, senator, or other elected official. Do you realize how many of the most filthy rich are increasing their fortunes by 500% ? Our country has been sold, we are being taxed to pay for it (regular taxes, food, oil, all other things foreign). TRAITORS, TRAITORS EVERYWHERE, AND NOT A ONE BEING CHARGED.

July 15, 2008 at 3:25 pm

Anthony E. Burke

Finally a journalist who gets it. There have been many who saw this coming but were ignored by the media. Do you remember FnWatch? My only hope is that this tradegy, coupled with a 9% approval rating for our congressman, will finally sink in with the voters. Every incumbent, from both parties,should be shaking in their boots. I'm an Independent and I assure you I'll be voting for "change" but not the kind being popularized in the media today- my change is not voting for any incumbents.

July 15, 2008 at 3:26 pm

Nick67

Ok, I sense your indignation--but isn't it misplaced? Just who deregulated the whole industry so that the whole Alt-A and subprime thing was even POSSIBLE? Especially afetr the S&L fiasco of the 80's? Both Freddie Mac and Fannie Mae are publicly traded entities. Their directors have a FIDUCIARY RESPONSIBLITY

July 15, 2008 at 3:28 pm

Kelly

Makes perfect sense. Pork spending is out of control and has been for years. Elected folks have one common ground and that is purely to see how fat they can get at taxpayer expense. We have a corrupt government and the only way for to reform it is to create a new poitcal pary that can withstand the hail storm from the 2 fat pigs that are now in existence.

July 15, 2008 at 3:32 pm

Mike Robinson

It is time for a revolution: No more War, No more Socialism, No more Lies. We need to cut spending and taxes by 50%. The USA is going to wake up with a big hangover and no aspirin. Call the doctor.

July 15, 2008 at 3:42 pm

maatt daamon...

Let's see... So people cannot afford their mortgages after the ridiculous increase in interest is finally applied to their previously bargain basement interest loans. As people cannot afford the incredible increase in their monthly payments, they stop paying their loans and let their houses be reposessed. In theory, these people could still pay for their houses at the given interest rate previously applied to the loan. In the worst case scenario, some kind of arrangement could be made. It is NOT IMPOSSIBLE. This economic crisis is only being compounded by corporate greed. Rather than give these "homeowners" a break in interest rates and still collect garunteed money for what they have lent, they would prefer to keep upping the interest so that ordinary people cannot afford them, and then force the government to bail them out so they still have billions and billions and trillions of dollars. These a**holes do not deserve the government bailout, just as they would not give out a mortgage for two and a half percent. This is what they expect from the government and greedily would not counter for those experiencing financial difficulties. The US is regretably going to fall into more and more trouble simply because greed is the order of the day. Who cares about millions of poor Americans when I got my millions? Typical corporate scum.

July 15, 2008 at 3:44 pm

Josqueline

This is a very informative article. I think it is really breaks down the basics of how, why and where are we going. Of course, no one knows what congress will do for sure, but we can all make a fairly educated guess. For my less educated family... all they see is the government is helping these large "corporate giants" and they are not helping the people who are loosing there homes left and right. It is hard to explain the complexity of "who's fault it is". As children we are taught the government regualtes itself through "Checks and Balances", but sometimes... it looks better on paper.

July 15, 2008 at 3:45 pm

maatt daamon...

hey! wheres my comment!?

July 15, 2008 at 3:48 pm

jason

Ok, I understand thet both these companies are failing and that no good solution is available. I cant help but wonder what the upside is tho. I'm not a buisness person, but what % of the loans that they hold not being forclosed on? If these are really behemoth companies cant they have a signifigant amount of loans that are being payed and arent being defaulted? Not to mention foreclosures are losses but not all lost, doesnt the bank typically resell the properties and recoup some of the losses? I understand this is a major problem, but in my dabbling of readings about wall street over the last few years it appears that the majority of information is 1/10 empty not 9/10 full, maybe a sideeffect about writing about money for so many years.

July 15, 2008 at 3:48 pm

Robert Rothenberg

It would be obvious that going forward, any GSE should have less leverage than they do now. That would affect long term profitability in rising markets which in turn would lead to lagging share prices. That would lead to the next question, Should they be publicly traded entities to begin with? The government has had to bail them out anyways and the total taxpayer cost is unknown but it will be significantly more than if the agenciews were government run to begin with.

July 15, 2008 at 4:03 pm

sergi

One of the most accurate analysis of F/F situation and congress attitude! Congratulation Elisabeth MacDonald

July 15, 2008 at 5:48 pm

jim brown

Matt you better wake up here. Your dollar has lost 40% against the Euro in the last few years. In 1964 a quarter would just about buy a gallon of gas. Today my 1964 quarters that are made of silver still almost buy a gallon of gas. The dollar has lost about 95& of its purchasing power since the Federal reserve was created. So the end of the dollar is already here. If you had bought Euro's a few years back you would have made 40% gains keeping them under you mattress. Holding dollars now why the Fed's printing presses are going full speed is like playing russian roulette with 6 bullets in the chambers. No chance of coming out ahead.

July 15, 2008 at 7:08 pm

Harry

Elizabeth: The flock of geese are smarter than Congress: The geese have the sense to know that when winter's coming head south before disaster strikes. Congress wanted everyone to have the American dream of owning a home, and turned aside from proper ovesight. Greenspan's every word was parsed as it were the word of God, except when it came to warning about Freddie and Fannie. Matt, Elizabeth's not the moron. Her blog has become one of the saner voices in a cacophony of reactionaries. You, on the other hand, are sniper with bad eyes.

July 15, 2008 at 7:30 pm

Roger

If this happened in the real work, and market forces were allowed to apply... This badly run company would be allowed to fail and competition would step in to take the business. Of course that can't happen here, but could they at least make sure all those involved loose their jobs and what's left of their business reputation? (oh, that probably can't happen here either..) Also, wasn't there an accounting scandal a couple of years ago at FannieMae? Did the ouster of Raines and Howard keep them from making other foolish mistakes? Oh, that's right, no competition in this scenario, I keep forgetting.

July 15, 2008 at 7:46 pm

Kurt9

The proper course of action to take with Freddie and Fannie is to place them in Federal receivership and to liquidate their assets. This is what was done with the Resolution Trust Corporation in the early 90's when the S&L's all went bust. Of course, our current congress is way too corrupt and fiscally irresponsible for such a course of action.

July 15, 2008 at 8:16 pm

Deacon & Usher

Usher: Hey Deak, check out the guys on the hill - they want the people who are getting whacked by the inflation to now pay for all the bad loans? Deacon: Yep, it's kinda like having to pay taxes on roadkill, Usher. Some say it's a free country, but it sure don't look like it from up here.....

July 15, 2008 at 8:52 pm

Ben

Sorry Matt, but you're sadly mistaken. This is an extremely well crafted snapshot of the current situation, and Elizabeth should be commended for putting all of this together. Matt, try and realize - you are the one who is having a difficult time wrapping your brain around the concept that your beloved GSE's will fail. You are seething at the fact that you are one of millions who will be paying the price for two organizations that were allowed to hold leverage ratios that no self respecting bank would even consider. Don't blame Elizabeth. You're 'shooting the messenger' as it were. I'm just glad that someone, somewhere was finally able to bring the picture into focus for me. Sometimes the truth hurts. But if you're not willing to go there Matt, there are plenty of other media sources willing to cater to the 'spin' you need to help you sleep at night. Thanks for this, Elizabeth.

July 15, 2008 at 9:10 pm

TJ

Great article. You were great on Cavuto yesterday. Matt, I think you need to explain yourself. Give your google sources.

July 15, 2008 at 9:43 pm

Bob Meyer

Elizabeth MacDonald understands the consequences of "saving" Fannie Mae and Freddie Mac much better than Matt does. Enormous wealth has already been destroyed by their mis-investment. There is no saving these economic corpses anymore than one can raise the dead. The economy is hemorrhaging from GSEs that are "free". They are free to act without serious regulation and also free from any bad consequences of their actions. If they make a profit they keep it, if they don't then someone else gets to pick up the tab. There is no better way to ruin an economy than to free people from the consequences of their actions. Transfusing the blood of the living into these corpses may give them the semblance of life, it may hide the fact that they are dead, but it will not stop these institutions from continuing to destroy wealth. Wealth must be confiscated to pay for this continued destruction and the consequences of that will dwarf the collapse of Freddie and Fannie. How many small businesses must go under, how many people must forgo retirement because their 401k's have plunged in value, how many households have to cut their food budgets so that Freddie and Fannie's incompetent managers won't have to worry about not being able to afford to have the barnacles scraped from their yachts? Plant these corpses now, before they stink up the entire country.

July 15, 2008 at 10:58 pm

DAVID

Let me get this straight....I, the lowly taxpayer, who keeps his bank account balance positive, his bills paid, and who was taught to balance his checkbook in the fifth grade, and is accountable for his own actions, must now loan these companies my money, because they never learned to keep their checkbook balanced ! Who goes to jail here ? No one because there is a "good ole boy" network within these companies and certain members of congress. I SAY, LET THEM FAIL.......PUT THE HEADS OF THESE COMPANIES IN PRISON, AND ANY GOVERNMENTAL FIGURE WHO PARTICIPATED IN OR OVERLOOKED THIS SITUATON BEFORE THE FIRING SQUAD. I will take care of myself, as I always have, without government assistance. If I make a mistake, who rushes in to infuse me with cash.....certainly not my government. It is time that the people of America wake up....THE MARCH TO SOCIALISM IS HERE.

July 16, 2008 at 1:46 am

Pat

matt daamon - the mortgages where interest rates are increasing were spelled out that way from day one: the paperwork had phrases like "ADJUSTABLE RATE", and told you what rate (e.g. U.S. Prime, LIBOR, etc.) would be used. I am neither a lawyer nor an accountant/financier, but when I signed an adjustable-rate mortgage a few years ago, I asked some plan dumb questions: "what will my monthly payment be now?" "what will my payment be in five years?" and so on. And, understanding my risk better, I chose freely to sign. It's nobody's fault but mine. The paperwork is available to any signer. If they choose to neither read it, nor spend $300 to have an attorney read it, then... sorry, but it's the signer's responsibility. If I am a bank, duh! I want to make money. If someone wants to take a loan from me and trade a lower payment now for higher payments later, duh! I'm going to give them the paperwork and try to sell it. And don't forget that millions of people *wanted* these loans so they could buy the house they wanted - nobody forced them to buy the $350K house instead of the $200K condo. So please don't spew that tired "evil corporations" crap. While some individual mortgage sellers may have lied about what's in the paperwork, that's why due diligence is always a wise thing on the part of the buyer. The much bigger problem here, as others here and elsewhere have so ably pointed out, is a government whose mismanagement of money is so stunningly bad that three generations' financial stability, even our nation's, are at risk. In the end, though, it's our fault as a citizenry: we got lazy and fat, and elected the people who made us the nicest promises. Result: deficits, debt, and a hundred trillion (yes, TRILLION) in unfunded liabilities for socialist insecurity and mediscare. Both parties - two sides of a socialist coin - are to blame, but we elected them. As far as I am concerned, the sooner the financial crisis or collapse hits, the sooner the demographic bump commonly characterized by their selfishness and short-sightedness (*cough* baby boomers *cough*) can be hit with it along with the rest of us and (be made to) participate in mopping up the mess rather than running away to Boca Raton, joining AARP, and perpetuating the problem.

July 16, 2008 at 8:26 am

frank

I bought a lot of their stock yesterday.

July 16, 2008 at 9:51 am

Geoff

Robt Rothenberg raised some interesting questions.. If the GSE's should be traded publicly then they should be held to much tighter standards and oversight than they were previously.. This entire episode reeks of mismanagement and lack of oversight with the participants knowing that even a debacle such as what we are witnessing is going to be bailed out.. It's another fraud and a screwing of taxpayers and investors.. Congress should be hauled out onto the carpet for this one, too ...

July 16, 2008 at 10:19 am

edfeeney

I think your fantastic Elizabeth but my heart belongs to Alexsis Glick. A new campaign to have you and Alexsis take over Cavuto's spot.

July 16, 2008 at 6:18 pm

Bill

Thanks for an excellent summary of our inability as a nation to balance short-term trading with long-term investment. The figures of speech are quite amusing. However, I must agree with Harry that geese know better than hang around for the winter. Those that did not fly south were subject to Darwin's law and did not pass along their defective behavior. I wish we could apply that principle to all the short-sighted politicians and regulators who promised anything with no regard to the consequences. A nice old lady bookkeeper who embezzles $100K from a small company will end up serving time. Why is Charles Keating not in jail ?? What about double-talk Greenspan, Mozillo, and the Wall Street perps who brought this on? The whole thing is one Ponzi scheme after another. We all pay for this rip-off every day at the food store and ga$ station with our general inflation tax.

July 18, 2008 at 10:16 pm

about this blog

  • Elizabeth MacDonald is the stocks editor for Fox Business Network. She is recognized as one of the top prize-winning business journalists in the country, and has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism, and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

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