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Wall Street Editorial on Fannie/Freddie--the next Enron?

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Anonymous

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Saw this in the Wall Street Journal yesterday.
And they didn't even mention the $50 no
appraisal fee.

elliott

WSJ 2/20/02 Editorial Page

REVIEW & OUTLOOK

Fannie Mae Enron?

We were reading President Bush's budget the other day (we know, get a life), when we came across an unusual mention of our all-time favorite companies -- Fannie Mae and Freddie Mac. What we found is a tale we think taxpayers and investors should want to hear.

It seems that Fan and Fred, two "government-sponsored enterprises" that hold the majority of all home mortgages in the U.S., have been growing their debt at an annual rate of 25%. They now have about $2.6 trillion in debt outstanding, a big number in any case, but really big considering that taxpayers are on the hook for it. The budgeteers also expressed some anxiety about Fan and Fred's increasing dependence on derivatives.

Hmmm. Where have we heard this before? The more we've since looked at Fan and Fred the more they look like poorly run hedge funds: lots of leverage and snarkily hedged risk. The word Enron ring any bells?

Last year, Fan's debt/equity ratio was about 60 to 1, more than five times the average for commercial banks. Moreover, as mortgage lenders, Fannie's equity can hardly be said to be well-diversified. Risk thus becomes a critical question.

Fan and Fred face two kinds of risk: credit risk from the possibility that mortgage holders will default, and interest-rate risk from the possibility that mortgage holders will prepay, leaving Fan and Fred on the wrong side of the spread, that is, lending at low rates and borrowing at high rates. Of course, giant risk won't lead to giant problems if it's properly hedged.

But Fan and Fred's risk management looks to be rather frisky. Take insurance. Some credit risk can be reduced by buying insurance against default. But lately the siblings have been cutting back on insurance, leaving them with greater exposure to default. Self-insurance may not be a dumb strategy in good economic times, but in a sharp downturn it can look pretty stupid.

As for interest-rate risk, Fan and Fred hedge with a giant and complex program using all manner of derivatives. At the end of 2000, their combined derivative position was valued at $780 billion. Even scarier, these hedges are only as good as the counterparties' ability to pay up. But Fan and Fred don't disclose the identity of their parties, so investors have no idea how much risk comes from possible counterparty failure. (By the way, last year Fan's derivative strategy went, um, somewhat amiss and she had to write down shareholder equity by $7.4 billion.)

Fan and Fred also pool mortgages and then sell those securities -- that is, they retain the credit risk since they guarantee the soundness of the mortgages and buyers assume the interest-rate risk. But Fan and Fred have recently been buying back their own securities; each now holds 30% of all mortgage-backed securities outstanding. Simply put, they are re-assuming interest-rate risk. Not necessarily a terminal practice when interest rates are stable, but dangerous if rates turn volatile.

Shaking in your boots yet? Well, there are even more parallels with Enron. Fan and Fred's financial disclosure is terrible. They are not required to file financial statements with the SEC. The New York Stock Exchange requires that they report to shareholders, but they keep disclosure and clarity to a minimum. Their financial statements are audited, for whatever that's worth. Last year Fan paid KPMG $2 million in audit fees and $6.6 million in consulting fees. Fred's auditor is Arthur Andersen; last year, Fred paid $1.1 million for auditing and more than $8 million for consulting.

Fan and Fred do have a federal regulator. It's the Office of Federal Housing Enterprise Oversight, and in 1992 it was required by Congress to produce a risk-based capital rule for Fan and Fred. Essentially OFHEO had to figure out how much capital they needed to survive a period of financial stress. Nine years later, last September, OFHEO finally published a rule that took some 600 pages to explain and that everybody found opaque. Informed suspicion is that the proposed standard is below that of other financial institutions and less than the capital that Fan and Fred currently maintain.

Then there's the matter of political influence. During the 1999-2000 election cycle, Fan spread around $1.6 million and Fred $2.4 million, giving to both parties about equally. The total of $4 million is almost double what Enron spent. And finally, there's Wall Street. Just as stock analysts sold the stuffing out of Enron's stock without having a clue about the true condition of the company, they are madly selling Fan and Fred despite the fact they can't possibly know what's what.

We aren't trying to scare readers here, and perhaps all of these concerns will come to nothing. So far during this recession, the housing market has held up well, knock on wood. Then again, unlike Enron, where only shareholders got taken to the cleaners, in the case of Fannie and Freddie taxpayers will take any bath. Maybe this time Congress should hold hearings before things go wrong.

Updated February 20, 2002
 
Joined
Jan 16, 2002
Kinda explains why they have been bashing appraisers for so many years and now feel they don't need them at all. It's like Enron having an honest
accountant, dosn't fit into their plans and scams.
 
A

Anonymous

Thread Starter
Guest
Have the wonderboys at Fannie
been selling their stock? Hmmmm?

elliott
 

Austin

Elite Member
Joined
Jan 16, 2002
Professional Status
Certified General Appraiser
State
Virginia
And you were going to retire when and live off your dividends, SS, and interest? Welcome to Wal-Mart. How about a big smile and a hug. The only retirement most people will see will be the seniors club at the coffee shop in Wal-Mart. I think Wal-Mart commercials are prophetic. Wonder if Mrs. Cleo needs an assistant?
 

Austin

Elite Member
Joined
Jan 16, 2002
Professional Status
Certified General Appraiser
State
Virginia
You guys will probably take this the wrong way, but all of these problems with Enron, FNMA, Freddie, etc, and almost everything else that has run amuck is a by-product of democracy. When the branches of government, courts, regulatory agencies, etc., cannot make a decision that cannot be over turned by public opinion, this kind of thing is the result. The form of government we presently have is not what our founding fathers gave us and is totally contrary to what the founding fathers intended. Our system has been bastardized out of existence and we are at the point now that we live by organized mob rule. Any system of government has to have some controlling authority with the wisdom to make the correct decisions and the power to do what needs to be done and make it stick. That use to be the senators and judges. Our founding fathers gave us such a system in the form of a republic and division of powers. Popular election of senators both state and federal, election of governors, and the politicalization of the judiciary is what did this country in. The judiciary in this country is nothing but a people’s revolutionary court created to enforce public opinion ruled over by some political hack politically appointed judge selected because of his political philosophy and not his judicial discretion or knowledge and love of the law. Have you read about the big fight going on in Washington about a judge Bush appointed. The left is fighting to destroy him because he will not say he will protect the right to kill the unborn and will not state before he is confirmed that he will do exactly what the civil rights click instructs him to do. It will get worse before it gets better. I heard a black civil rights advocate say she opposed this judge because he would not agree to send people "accused of racism" to jail because of the seriousness of the charge. I said accused not convicted. We can have the trial later, lets sent them to jail now. And nobody questioned her.
 
Joined
Jan 13, 2002
Professional Status
Retired Appraiser
State
Florida
Austin,

Some days you are just too profound 8) You always make a lot of sense. You know the horse sense kind of logic. 8) But some days you out do yourself. An example is the post above. Not a good picture, BUT we will survive. You hit the nail on the head with the lack of leadership. Eight years of running the country with polls shows the real LACK of leadership and vision that our government had. 8O It also shows how far we have sunk by not focusing on our priorities. Good leadership allows people to be free and rise to their own level of excellence. Have a good one. :wink: :wink: :lol:
 
Joined
Jan 16, 2002
Hey Austin:

I think you right, let's try a Benevolent Dictatorship with you and me in charge. We'll straighten out this whole mess in a couples of weeks :)

Regards,

Ranting Joe
 
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