Thursday, July 10, 2008

Fannie and Freddie

Fannie Mae and Freddie Mac have been in the news lately over a precipitous decline in stock values, plunging sharply toward near-worthlessness from a relatively stable plateau as late as fall '07 (FNM and FRE). Given their sizable role in the credit industry, it deserves comment here.

The two companies are part of a collection of Government Sponsored Enterprises (GSEs) that exist to facilitate credit to certain markets, in this case low-to-moderate income houses. They were chartered into existence by congress, however operate as a private corporation with shareholders and profits, and explicitly no government guarantee of their securities, however an implicit one is up for debate. Essentially they buy loans from banks, package them as securities, and sell them to private investors.

This is not an unreasonable business model, so long as everybody pays their mortgages with only a trickle of foreclosures, which has been the case for years—until the subprime crisis. My Internet seach on their degree of subprime exposure turned up plenty of contradictory statements from various news sources, which to my mind leaves the matter inconclusive. Apparently the market is suspicious of either subprime exposure or oncoming Alt-A exposure. In any case, Freddie Mac has admitted to $12 billion in subprime losses, and support of low- and moderate-income home ownership is part of Fannie Mae's mission statement.

Their accounting scandals of a few years ago suggest they do not operate in a culture of honesty, so, all things considered, their exposure to shaky mortgages is probably high, they are facing serious capitalization problems, they are probably having difficulty arranging privately funded bailouts like WaMu and Wachovia, and so a market exodus is probably sensible. Talk of a bailout has begun but is diffuse and vague. No doubt there will be more to say as this drama unfolds.

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