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Friday, August 11, 2006

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.


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.


Anonymous said...

Hmmm... where's Niel Bush when you need him? Call me a conspiracy theorists but this looks like the largest payout of corporate welfare ever seen by the likes of Gawd.

So let me get this straight s-crow, is the following scenario below actually playing out?

For starters ma n' pa computer programmer buy a 500K house in Ballard using a neg-am/i-o sold to them by a dodgy local fly-by night lender, that lender immediately sells it off to some middle-man, for a period of time. The mid-man take their cut and then sells that loan upstream to Fannie Mae/Freddie Mac before it becomes totally toxic and reaches critical mass. At which point FM/FM bundle that loan into a mortgage backed security and sell it to pension funds, foriegn banks,etcetera...

What happens when those loans go into their inevitable default? Who owns the property at that point and is left hold the bag? What happens?

There's got to be some regulation in their somwhere... maybe I'm missing something...

Eleua said...

If F.D.Raines had my complexion, he would definitely be getting the Ken Lay treatment (well, what Ken Lay was looking at prior to his demise.)

Anonymous said...

I'm disgusted by the prospect of yet another high-profile corporate scandal. Especially if the gov. makes a move to bail out these d!cks. I'm probably not the only one sick of execs with obscene compensation packages, yet whose contempt for business ethics and oversight will affect the livelihood of so many US citizens--and erode investor's trust.

Sometimes "perp walk" is too good for these guys. Perhaps the French had it right in 1789, when they introduced their Executive Downsizing Plan. (tongue-in-cheek, of course!)

Eleua said...

How does one lose track of $16B? Actually, I think FD Raines had $8.9B go 404 on him.

Now, how do you accomplish that?

No, really?

If your stated goal was to have $9B go missing, how would you do it?

Either FD Raines is the DUMBEST SOB on the face of the earth - I'm talking about a -4 sigma IQ - or he is as corrupt of a man as you will find.

After you lose $9B, do you just get to take a Mulligan and say "Whoops, my bad?"

If he loses $9B, just who is in charge of watching him? WTF have they been doing all this time?

I know two things:

This isn't the only grenade rolling around on the floor.

This grenade will be measured in mega-tons.

Anonymous said...

Fanie Mae hasn't reported their financial statements since what? 2004? But they're still listed on the NYSE. Right? That's supposed to be against the law.

Note, they're talking about delisting Apple because they missed one quarter.

Somebody correct these "facts" if/where wrong.

Also, the Treasury Dept's. top official, on domestic finance matters (Randall Quarles) handed in his resignation 2 days ago.

He's been the "point person" in pushing the Administration's efforts to reform Fannie Mae and Freddie Mac for the past 5 years". (AP, Friday Aug. 11'06).

Good timing on unloading that job eh? Five years is a long time to get absolutely NOTHING done.

Anonymous said...

Matt- I too am very curious about what happens to these toxic bundled loans and at what point organizations will refuse to buy them.

There's a blogger in Germany who's done a bit of posting on thehousingbubbleblog about these MBS's beginning to be "returned to sender". Somebody said the secondary buyers have a year in which to return them if they decide they don't want them afterall.

They've just started to trickle back.

There's a post about another bunch that are being returned on this site:

So we appear to be in the beginning stages of "thanks but no thanks" when it comes to offing responsibilty for bad loans from original lenders to Greater Fools.

I'm presuming that once enough people refuse to buy this junk, lending rules will have to tighten.

Anonymous said...

And when lending rules tighten, watch those house prices plummet-

john_law_the_II said...

Raines has gotten a pass not because of the color of his skin, but because fannie is too big, has big-time political connections, is one of the largest political donors.

there is a reason why they haven't been delisted.

Anonymous said...

I completely agree with John...

Yes, my feeling is that this mess has the potential to be so big and there could be such fallout for the financial markets and politically, that there is going to be a substantial amount of closed door strategizing on how to keep Fannie and Freddie from taking down the markets.

To think that this Franklin Raines character had a cabinet position in the White House and could have been Treasury Sec. just blew my mind.

john_law_the_II said...

Enron was $90B company, FNM holds like 20-40% of all mortgages in the US?

Anonymous said...

I work at Boeing in Renton & Boeing has sold a heck of lot of real estate arround there plant. The funny part is these Condo projects use Boeing Workers at least the ones I know "could only go as far as getting the tour.

- Dallas-based Harvest Partners is planning to unveil plans for a shopping-theater complex roughly twice the size of University Village, along with a high-rise residential development that could bring thousands more residents to Renton. Construction could begin as early as the spring.

- The project is to include a retail-restaurant complex and a movie megaplex totaling about 800,000 square feet — essentially the region's first major new shopping center in years — and 900 to 1,000 units of housing, probably some combination of condominiums and apartments.

Wow. It is a nice site there on Lake Washington. The property is on the very south end of the lake next to the Boeing 737 production plant:

Anonymous said...

900 to 1,000 units of housing, probably some combination of condominiums and apartments.

Nice to hear they're planning for an eventual oversupply to offset current living costs.

Anonymous said...

Thats what Im thinking.. Maybe in about 2 years I will be able to rent one those units for about 900. dollars a month, not the 1 bedroom units.. make that 2 bedrooms..

Thats about what Boeing Wages support... seriously I have been working for Boeing for 6 years and my take home is 1,300. dollars every 2 weeks, Impressive-Not Hardly.

I figure 400.+100. utilities cost is in the ballpark of Boeings wage guidlines. Thats just about 20% of my wages just renting half a Apartment.

Anonymous said...

I was figuring the statment above on having a roommate to share the cost on that 900. dollar unit.

Maybe thats a pipedream.. that rents would be that low. Just seems like a lot of units 1000 and maybe a lot of those units will end up being part of the rental market? it depends a lot on how bad our economy is in a couple of years.

It will be highly doubtful any of my co-workers can currently come close to affording any of those units. There is a few however its only because there current residences have appreciated so much in the last several years.