US Financial Systemic Risk: Fannie Mae & Freddie Mac

I know many readers have asked me to provide information regarding the tightening of lending standards. In researching this (maybe some loan officers that sleuth this site could be much more helpful) I did find the following:

August 11, 2006--Federal Deposit Insurance Corp. Chairman Sheila Bair says federal banking regulators are still a few months away from finalizing guidance on interest-only and payment-option mortgages.

This shows that the "guidance" and any recommendations will probably not occur until some time later (as in 2007).

Now for the meat 'n taters

Both Fannie Mae & Freddie Mac are the country's largest private mortgage buyers.

It appears that from all indications that financial problems at Fannie Mae and Freddie Mac, due to the mismanagement and risk associated with these institutions, could possibly result in the largest financial scandle in US history. Both of these institutions represent over 40% of the entire US mortgage market. The scale could make Enron's debacle look like a tug boat parked next to the USS Abraham Lincoln.

After Fannie Mae's having to restate earnings in the billions and recent filing with the SEC that they will miss another (possibly for the foreseable near-future) deadline for financial reporting, the investigations into these companies is revealing the potential for systemic risk to the US financial markets. Time will tell.

History

In 1968, Fannie Mae became a private company operating with private capital on a self-sustaining basis. Its role was expanded to buy mortgages beyond traditional government loan limits, reaching out to a broader cross-section of Americans.

"Today, Fannie Mae operates under a congressional charter that directs us to channel our efforts into increasing the availability and affordability of homeownership for low-, moderate-, and middle-income Americans. Yet Fannie Mae receives no government funding or backing, and we are one of the nation's largest taxpayers."
- From Fannie Mae's website.

The Risk

"The result of the Enterprises' rapid growth unconstrained by market forces and a weak regulator was years of mismanagement, flagrant earnings manipulation, and systems-and-controls problems. Managements of both companies were forced out, earnings were misstated by an estimated $16 billion, fines exceeding one-half billion dollars were imposed, and remedial costs will exceed $2 billion" - OFHEO

Of the five unique systemic risk factors as reported by the Office of Federal Housing Enterprise Oversight (OFHEO) , the government office tasked to investigate the companies, the second risk factor just blew me away.

"Second, Fannie Mae's and Freddie Mac's low capital requirements (much lower than traditional banking institutions) and unusually low funding costs because of their GSE status allow them to build huge mortgage asset portfolios. Fannie Mae's mortgage assets grew from about $124 billion in 1990 to $905 billion in 2004, and then declined to about $727 billion last year. That's equivalent to average annual growth of more than 13 percent over the 15-year period. Freddie Mac's mortgage portfolio grew 26 percent per annum from less than $22 billion at year-end 1990 to $710 billion in 2005. In contrast, the residential mortgage market grew at an average rate of 8.5 percent. Absent regulatory constraints, Fannie Mae and Freddie Mac could each increase their portfolios by well over $100 billion without exceeding the present minimum capital rules, including the 30 percent operational risk requirement that OFHEO imposed."

If you read the papers, you know that the CEO's at the top, such as Fannie Mae's Franklin Raines, resigned under serious allegations of corrupt management. The bonuses were obscene (tens of millions) and allegations of "cooked" books appear to be coming true.

An interesting side note: If John Kerry had taken the White House, many had pegged Raines to be Treasury Secretary. Franklin Raines was the Director of the Office of Management and Budget under President Bill Clinton. (I'm not making a political statement, these are facts.)

Further, Raines grew up in Seattle.

Whether or not people feel Raines and his executive staff/subordinates should be in jail is for debate on another blog. Many in Washington feel it is only a matter of time before he is idicted.