Wednesday, July 23, 2008

Fannie Mae and Freddie Mac: Trouble doesn’t stop at $25 billion

Fannie Mae and Freddie Mac: Two iconic firms that drive the mortgage market are in distress. The housing market is under and will continue to suffer duress, and the Fannie and Freddie debacle is serious, but the government will of course back the two giants if either were to become insolvent.

To that avail, the House of Representatives is voting on a bill to rescue Fannie Mae and Freddie Mac. The bill includes Secretary Paulson’s recommendations for a “bailout”, but certainly represents the old saying, “too little too late.” Fannie Mae and Freddie Mac have been subject to low standards relative to private financial firms, holding just barely enough capital to stay afloat. The government entity in charge of monitoring the mortgage giants, the Office of Federal Enterprise Oversight (OFHEO), has not done its job.

If home values do not stabilize soon, the U.S. Treasury may be forced to loan an obscene amount of capital to Fannie Mae and Freddie Mac, or to nationalize the firms all together.

The euphemistic calculations

According to the Congressional Budget Office (CBO), there is less than a 50% chance that the two mortgage giants would access the lines of credit approved by Congress to recapitalize their balance sheets. However, if the Treasury is forced to bailout Fannie and Freddie, it will cost $25 billion (to the taxpayers, of course). Further, there is a 5% chance that the cost of the bailout could total $100 billion.

I say, if it costs $25 billion, then let’s do it and move on. The sum of $25 billion is certainly a lot of money, but the Fed and the Treasury are used to tossing billions out on a whim.

The Fed loaned JP Morgan $28 billion to aid the buyout of Bear Stearns. The Federal Government sent out rebate checks totaling $114 starting in May 2008. $25 billion is pittance compared to the $1 trillion in estimated financial losses stemming from the U.S. mortgage market.

Now the euphemism is over

However, the delinquency rates on mortgage loans are high and rising, and Fannie and Freddie could be in much more trouble than the $25 billion CBO price tag.

The fare value market capitalizations of Fannie Mae and Freddie Mac are around $10 billion $5 billion, respectively . If Fannie Mae’s assets value dropped to zero (including mortgages), then it would have $11 billion to cover its financial obligations (liabilities). Um, problem.

As of Jan.1, 2008, Fannie Mae’s liability value was $839 billion, and $10 billion, or 1.3%, is not enough to cover the continued rising foreclosure rate as house prices fall through 2008 and into 2009. As long as home prices are falling, Fannie Mae and Freddie Mac are grossly undercapitalized.

According to the NY Times, Fannie Mae and Freddie Mac own $1.5 trillion in mortgage securities and home loans. Approximately 4% of all loans are grossly delinquent (90 days or more late), and that means losses of roughly $60 billion, or about $45 billion short of Fannie and Freddie’s current capital value. Since home values are expected to decline into 2009, delinquency rates will likely rise, and losses could be higher.

My point is that we could be in trouble here, and the price tag for a bailout may be largely excessive of $25 billion….perhaps too much for the government to bear. One option is that they could simply take on Fannie Mae’s and Freddie Mac’s troubled balance sheets and nationalize the mortgage industry. The media obviously does not deem this an option, since “bailout” is the only reported choice. But at least if the firms were nationalized, the taxpayers would own not just the liabilities (bailout) but the assets as well.

The key to recovery is home prices. As they start to stabilize, the outlook for Fannie Mae and Freddie Mac will turn from dismal to hopeful. But whatever the outcome, these giants need to be reigned in with more capital oversight.

Please leave comments. Best, Nontruths

1 comment:

  1. You're right. The government is just throwing money around by the billions with no thought to tomorrow as long as it satisfies all the people with their hands out. Weel, they print the stuff so I guess they can do that.