|To: JDN who wrote (60085)||4/11/2004 9:14:42 PM|
|From: High-Tech East||Read Replies (1) | Respond to of 64860|
|<<Better get a new banker!! As many of you know I am on a Bank Board>>|
... not some tiny little bank in Ft. Lauderdale, JDN ... <g>
... some big banks like JP Morgan/Chase, Citibank and Bank of America who own almost all the derivatives in the world ...
... and Fannie Mae and Freddie Mac, who own most American residential mortgages ...
Playing with fire - Fannie Mae and Freddie Mac, The continuing concerns about America's twin mortgage giants
April 7th 2004
From The Economist
Of all the things that might upset America's financial system, top of most lists are Fannie Mae and Freddie Mac. The two companies stand behind $4 trillion-worth of mortgages; when that much money is involved, even a minor glitch can send tremors through financial markets. Recently both have had more than their share of problems with their accounts. There are shortcomings in their regulation. If there were a disaster, no one could say that it had come without warning.
Re-regulation has been talked about for years. But Fannie and Freddie are reckoned to be among the cleverest and most generous lobbyists in Washington. When the prospect of new rules looms, as it did recently, they seek popular support by running melodramatic advertisements claiming that change could make homes unaffordable for many Americans. Their most recent victory over their critics came on April 2nd, when their allies in Congress thwarted the efforts of the Bush administration to tighten their regulation.
Fannie and Freddie enjoy an implicit guarantee of their debt by the federal government. This gives them a great advantage in a business where the most significant cost is funding. The two have long argued that the true beneficiaries of this are homeowners, who pay lower interest rates than they otherwise would.
This is nonsense, according to no less an authority than Alan Greenspan, chairman of the Federal Reserve. Citing a Fed study, Mr Greenspan told Congress in February that the government guarantee gave the twin companies a funding advantage of 40 basis points (hundredths of a percentage point). However, a mere seven basis points were passed on to mortgage interest rates—an amount too trivial to have a substantial impact on home ownership. The rest went to Fannie and Freddie.
Worse, the guarantee means that Fannie and Freddie are not subject to normal market disciplines. That might encourage them to take extra risks—for which taxpayers would be expected to pay if anything went wrong. Fannie and Freddie are highly leveraged and do not pay for the associated risk. “There are many ways to enhance the attractiveness of home ownership at significantly less potential cost to taxpayers,” Mr Greenspan said.
Republicans on the Senate Banking Committee pushed through a new regulatory package, with the initial support of the Bush administration. This would have ended Fannie's and Freddie's exemption from bankruptcy laws and placed any insolvency in the hands of a new regulator, who would also set minimum capital requirements and be funded by levies on the companies. Just before the final vote a provision was added, putting Congress in charge should Fannie or Freddie go bust. This would maintain the ties between legislators and the companies that the administration had hoped to sever. The administration therefore withdrew its support for the new law. Now nothing is expected to happen this year. If the Democrats take the White House in the autumn, nothing is likely for the next four years. Unless, of course, Fannie or Freddie blows up.
Short of outright disaster, the case for re-regulating Fannie and Freddie could hardly be stronger. Each has had problems with its accounts. Freddie's have looked the worse. It has acknowledged that it went too far in smoothing earnings in the past. It will not announce its profits for 2003 until at least the end of June. At the end of last year, it fired its chief executive, at great expense. Gregory Parseghian had spent half a year in the job, having being promoted from chief investment officer; he received a salary of $1m, a bonus of $4m and severance benefits of $14m. Yet many believe Freddie is in better shape than its sister, if only because its clean-up is more advanced. A deep accounting audit is under way. New contracts for its executives stipulate that bonuses will be paid only if there are no nasty surprises.
Fannie's accounting problems are more subtle. On April 1st its regulator, the Office of Federal Housing Enterprise Oversight (OFHEO) said that Fannie might have to restate its accounts, because its loans for manufactured (ie, prefabricated) housing and other assets had become impaired. The company issued a denial that was labelled “inaccurate and misleading” by OFHEO's director, Armando Falcon. It is hard to imagine such a dispute between a big bank and the Fed or the Securities and Exchange Commission.
Fortunately, Fannie's manufactured-housing portfolio, at $8 billion, is not big enough to cause a panic. More significant is its use of derivatives which, according to John Barnett, of the Centre for Financial Research and Analysis, provides a technically correct but misleading impression of earnings. When interest rates fall, homeowners refinance, creating a potential loss for mortgage holders. When this happened to Fannie, rather than take the loss up front, the company used derivative contracts that under generally accepted accounting standards amortised the cost over several years. Had the decline in the market value of its bond portfolio since 1997 been fully recognised, by last year Fannie's capital would have been 20% lower—enough to push its capital below the regulatory minimum.
Doubts about Fannie's figures have not gone entirely unnoticed in the markets: its share price is depressed. If there are more questions about the twin companies' accounts, even their friends in Congress may one day bow to change. That, however, has been said before.
Copyright © 2004 The Economist Newspaper and The Economist Group. All rights reserved.