Fannie and Freddie...

[Little Raven]

And a possible bailout.

Here's a scary, and relevant, question to ponder as the housing market continues to slide: What would it take for the government to step in and help Fannie Mae and Freddie Mac, and how would a rescue affect you, the taxpayer?

A Lehman analyst's note on Monday sent shares of both companies plunging. Though they've recovered some, the fall, and Fed Chairman Ben Bernanke's downbeat outlook for housing issued Tuesday, is forcing investors to consider what would happen if a bailout is needed.

Hang on here. Fannie and Freddie buy mortgages, right? So if they go under, banks will want to issue fewer mortgages, and the housing market will get worse.

That's supposed to be a disaster scenario? It seems to me that a government bailout is much, much worse.

[The Preacher]

That's supposed to be a disaster scenario? It seems to me that a government bailout is much, much worse.

Why is that? I'm not challenging you, I'm just not sure I understand why it's worse.

[Little Raven]

Why is that? I'm not challenging you, I'm just not sure I understand why it's worse.

Well, for starters, from the article...

The doomsday scenario could cost taxpayers more than $1 trillion, says the S&P report. The report went so far as to say that a government bailout of Fannie or Freddie could force the agency to lower its rating on the creditworthiness of the United States.

(Note: The 'doomsday' scenario refers to a government bailout of Fannie or Freddie, while the 'disaster' scenario refers to letting them go under.)

Having the creditworthiness of the USA downgraded strikes me as a wee bit worse than letting the housing market take another blow on the chin. Sure, having home prices drop even lower is not ideal, but we've managed so far.

Besides, if an industry requires a government bailout (let alone a 1 trillion dollar bailout) to remain solvent...isn't that a pretty clear sign that something is desperately wrong with said industry? Something the market should be allowed to fix?

[Zarathud]

That assumes you have a fully functional market that can handle the turmoil. Freddie Mac and Fannie Mae are government-sponsored enterprises of the United Stated federal government. While privately owned, the prior government relationship created the widespread perception that they are government backed despite explicit statements to the contrary.

[Little Raven]

Secretary Paulson needs to shut up now.

Treasury Secretary Henry Paulson, seeking to calm nervous investors about the financial state of Fannie Mae and Freddie Mac says the government's primary focus is making sure that mortgage giants Fannie Mae and Freddie Mac remain as presently constituted to carry out their mission.

The more he talks like this, the greater the pressure for a government bailout is going to be. And this is one $5 trillion mess that the taxpayers should have no part of.

[The Preacher]

While a bailout might be pretty bad (depending on how its done), the repercussions of Fannie and Freddie collapsing are pretty scary, LR. The essence of the second option is what happens when banks stop originating new mortgage loans?

Between the two, they are probably buying nearly half the mortgages originated. If banks can't sell mortgages, then they would be forced to either (a) keep them on the balance sheet eating up valuable cash reserves in a day and age when every dollar is essential or (b) stop issuing new mortgages. You think the housing market is bad today? Imagine if half of people who wanted to buy were no longer offered them because banks were too illiquid. I think that would be absolutely catastrophic to the economy. Foreclosure would grow even higher since no one could sell, people would be unable to relocate, banks take possession of more properties eating up more capital driving down the number of mortgages that they could issue, they dump more properties at even lower prices cratering home values which creates more negative equity situations and the feedback loop continues. When does that cycle break? Most likely, when the Fed steps in and stops it.

So the question is really: when should the government step in? It is not if they should do so (imho).

[Little Raven]

While a bailout might be pretty bad (depending on how its done), the repercussions of Fannie and Freddie collapsing are pretty scary, LR.

I realize that refusing to have the government bailout Fannie and Freddie does not mean the situation goes away. But we're not talking about another Bear Sterns here. That little adventure only cost the taxpayers $20 billion or so. Fannie Mae and Freddie Mac have liabilities of over $5 trillion. Note the t. Even if we're willing to turn the Fed into the largest owner of real estate in the country, how exactly are we going to raise that kind of cash? The Fed's almost tapped and we haven't even bailed out Citi yet.

As ND likes to point out, while the national debt may be large, (~9 trillion) it's still manageable given our GDP. But throw Freddie and Fannie on there, and all of sudden we start looking a lot like Argentina back in in late 90s.

I would think that the answer to the question of when the government should step in would be when it can afford to. And I'm not sure that even the government can afford Freddie and Fannie in the near future. The numbers are just too big.

EDIT -

I note that Krugman agrees with you, though.

Will Fannie Mae and Freddie Mac have to be bailed out by taxpayers? I have no inside information, but I’d say yes, for two reasons.

First, as Reinhart and Rogoff document, big financial crises always end with an expensive bailout of the banking system. It happened in Sweden, it happened in Japan. Why should we be different? Except that in this case banks proper took on very little of the risk; Fannie and Freddie, on the other hand, took on a lot of it.

Second, the housing bubble was immense; see the figure above, taken from the always excellent Calculated Risk. Fannie and Freddie only guaranteed conforming loans — loans that weren’t that big, didn’t have exotic financial features, and required a substantial downpayment. But so what? If real prices of houses in places like LA return to historical norms — and there’s no reason to think they won’t — many, many borrowers with conforming loans will end up with big negative equity anyway, and this in turn will produce a lot of defaults.

*sigh*

[Ranulf]

Tagline from another forum I read: "Freddie's Fannie pounding continues..."


Anyway, The "Fed" is already involved in this deeply as is the Fed government. While I can see a reason to bailout some banks/lenders/mortgage holders to stave off a major crash in home values/keep people in their homes, the problem is by how much and is it worth it long term? Housing has jumped up far too much in the last 5-10 years and is not equal with income. Prices have to come down. I'm not real keen to buy a house I saw last year that's gone up 90k in appreciation in a mere 3 years ( its down to about 60k over 4 years now, it was 90k last year) in a flooded market. A house that was worth 224k in 2004 is not worth 319k in 2007. That was the dream price, it sold after 6+months on the market for 285k and is now back on the market at 285k (pity those buyers for whatever reason they're selling again so soon). Yeah, I'm not catching that knife for a 15 year old house with at least 30k in possible upgrades/repairs needed in the near future.

imagine if half of people who wanted to buy were no longer offered them because banks were too illiquid.

Already there with the death of subprime/alt-a/ninja loans and helocs. Not too many folks have the savings/income to put 10-20% down, certainly not at many of today's housing market prices.

[The Preacher]

imagine if half of people who wanted to buy were no longer offered them because banks were too illiquid.

Already there with the death of subprime/alt-a/ninja loans and helocs. Not too many folks have the savings/income to put 10-20% down, certainly not at many of today's housing market prices.

No, we're not. I'm talking half of today's mortgages! While I agree with and appreciate your sentiments about housing values, what we are presented with isn't likely a price "adjustment", it's probably a collapse. Think 1929.

[The Preacher]

Fannie Mae and Freddie Mac have liabilities of over $5 trillion.

That isn't the risk though. From your first link, you'll note that the "doomsday" situation S&P estimates is $1T. Not chump change by any means, but that is "doomsday". The more we can do to prevent "doomsday" (like acting quickly and decisively), the less that bailout will be.

I would think that the answer to the question of when the government should step in would be when it can afford to. And I'm not sure that even the government can afford Freddie and Fannie in the near future. The numbers are just too big.

The decision isn't going to take place over years. It's over the next couple fiscal quarters. According to your stories, they each probably need to raise $7B in the next two quarters to remain solvent. They have market caps of $8B before they try to issue new stock. There is next to no way that they will be able to get $7B from the capital markets.

*sigh*

Yeah, it ain't pretty. And you'll pay special attention to one of Krugman's points: these are conforming loans. In other words, no subprime, no jumbos (> ~$400k), 20% down. These are good credit people with good equity in their homes (relatively speaking). This far, far worse than the subprime debacle, which it can be reasonably argued had no equity to begin and thus little to lose. There are tremendous long term losses at risk here (e.g. ready to beef up social security since no one has equity in their homes upon retirement?).

[The Preacher]

Fannie, Freddie Media Panic Overblown
He raises some excellent points. The fact that FAS-140 is driving this is ludicrous, although it does point to the general issue with FAS-140 as it will be faced by many, many banks.

[Canuck]

What the hell kind of name for a company is Fannie Mae and Freddie Mac? It sounds like a bunch of yokels who are offering loans.

[Grifman]

I realize that refusing to have the government bailout Fannie and Freddie does not mean the situation goes away. But we're not talking about another Bear Sterns here. That little adventure only cost the taxpayers $20 billion or so. Fannie Mae and Freddie Mac have liabilities of over $5 trillion. Note the t. Even if we're willing to turn the Fed into the largest owner of real estate in the country, how exactly are we going to raise that kind of cash? The Fed's almost tapped and we haven't even bailed out Citi yet.

Huh, you're forgetting something, along with the liabilities of over $5 trillion , they also have assets of over $5 trillion. Duh! You can't forget the other half of the balance sheet! And the $1 trillion dollar figure is waaay too high, unless you believe that 20% of the mortgages held by these two are going to go bad - which is an unheard of rate, and even more unlikely since they take only the best loans, not the worst ones.

Could it be expensive? Yes. A trillion bucks - no way, unless someone's predicting another Great Depression or worse with 20% of mortgages going bad.

FYI, from the link The Preacher gave above:

Comparing the size of the GSEs' guarantee portfolio ($4.5 trillion) to the national debt, or some such, is a spurious comparison, to put it politely.

And fyi, Bear Stearns hasn't cost the US govt anything. That was just a guarantee, a backup to JP Morgan. As far as I know the Fed hasn't spent anything on Bear Stearns.

[Grifman]

What the hell kind of name for a company is Fannie Mae and Freddie Mac? It sounds like a bunch of yokels who are offering loans.

Those are the names, those are nicknames given the abbreviations for those entities:

FHLMC
FMNA

[Zarathud]

Huh, you're forgetting something, along with the liabilities of over $5 trillion , they also have assets of over $5 trillion. Duh! You can't forget the other half of the balance sheet!

Except the other half of the balance sheet sucks. To use your example, the liabilities are constant (or increasing), and the value of the assets is decreasing. That's a weak balance sheet.

The variation is that Freddie/Fannie are guarantors of the loans they've repackaged. That means Freddie/Fannie are ultimately on the hook for the mortgage crisis. That's bad, bad news.

And the $1 trillion dollar figure is waaay too high, unless you believe that 20% of the mortgages held by these two are going to go bad - which is an unheard of rate, and even more unlikely since they take only the best loans, not the worst ones.

The concern is whether there is a cascading effect from lower property values reducing the value of property, increasing interest rates causing more foreclosures, and the problem that it makes economic sense to walk away from properties with negative equity. A 10% failure isn't necessary because of the significant leverage which amplifies the economic pressure of more than usual rates foreclosures. And we're in a potentially historic situation. Bottom line, Fannie and Freddie horribly mispriced their risk and leverage amplifies the problem.

The article posted by The Preacher is very interesting, but it also confirms that both entities are under huge pressure and an an impossible situation:

Not only are they the biggest non-Treasury issuers of straight-debt securities, mortgage-backed bonds guaranteed by the two giants represent over 30% of the total taxable bond market. Therefore, the problems at the GSEs probably touch just about every investor directly in a way few other companies would.
While delinquencies on their guarantee portfolio remain relatively small (0.81% for Freddie Mac and 1.22% for Fannie Mae), the fact is that both companies employ tremendous leverage, and therefore, losses even mildly above historic norms are likely to put huge pressure on the company's equity.

In addition, Freddie Mac has yet to complete the $5.5 billion capital raise they promised in May, and given market conditions, this will be all but impossible without government intervention. So I'm not here to challenge the plunging share price of either Fannie Mae or Freddie Mac.

If it's true that accounting changes from FAS-140 are helping drive the crisis, that's unfortunate timing. But we've known since Enron that off-book balance sheets are bad news when a company has misjudged the market. While the cost might not be $1 trillion, the government has been expected to support Freddie/Fannie's guarantee of mortgage-backed securities under a less-than-conservative accounting system. That's not right no matter what the ultimate cost to taxpayers.

[The Preacher]

Huh, you're forgetting something, along with the liabilities of over $5 trillion , they also have assets of over $5 trillion. Duh! You can't forget the other half of the balance sheet!

Except the other half of the balance sheet sucks. To use your example, the liabilities are constant (or increasing), and the value of the assets is decreasing. That's a weak balance sheet.

The variation is that Freddie/Fannie are guarantors of the loans they've repackaged. That means Freddie/Fannie are ultimately on the hook for the mortgage crisis. That's bad, bad news.

To be clear for the layman in the room, they are on the hook for their portion of the mortgage crisis. That means no subprime, no jumbos (>$400K) and very few ARMs (I believe less than 10% of their balance sheet is ARMs). What it does demonstrate is why it is a bad idea to loosen their policies to help prop up the subprime debacle.

If it's true that accounting changes from FAS-140 are helping drive the crisis, that's unfortunate timing. But we've known since Enron that off-book balance sheets are bad news when a company has misjudged the market.

Bad assets is not the primary issue with FAS-140, although the rule is meant to make financial institutions more accountable for risky loans. It's that the companies need to recapitalize to take all these assets back on their balance sheets, regardless of the credit quality. Then you layer on increasing delinquency and you have a double whammy.

Comparing this to Enron's off balance sheet doings is simply wrong. Enron was creating false transactions (i.e. not arms length) to move things between balance sheets. What is occurring with FAS-140 is completely changing the securitization market. Almost all loans in this day and age are sold off to investors as securitized loans. And every company is moving them off their balance sheets as a result of that sale. FAS-140 is changing the gain on sale accounting that has been in place for 20+ years. These financial institutions have been operating above board in all of these transactions.

While the cost might not be $1 trillion, the government has been expected to support Freddie/Fannie's guarantee of mortgage-backed securities under a less-than-conservative accounting system. That's not right no matter what the ultimate cost to taxpayers.

The change to the accounting is arbitrary even if it has merit. The entire financial system played by the rules of the game, unlike Enron or Worldcom or any of the other 2001-2002 debacles. If you don't want there to be fall out, don't change the rules. If you want the system to be more conservative, be prepared for the backlash. The choice is ours.

And lastly, if you don't think the taxpayer has benefited from this accounting treatment, then you are quite mistaken. The liquidity created by these standards allow a far greater number of people to enjoy loans than they did prior to the 80's (when the asset backed securities were first devised by Salomon Brothers {Liars Poker is a great read on this development}). While we may have to pay, and as Grif points out we may never have to do so, we have also benefited. It has probably been a fair trade overall.

[Grifman]

Huh, you're forgetting something, along with the liabilities of over $5 trillion , they also have assets of over $5 trillion. Duh! You can't forget the other half of the balance sheet!

Except the other half of the balance sheet sucks. To use your example, the liabilities are constant (or increasing), and the value of the assets is decreasing. That's a weak balance sheet.

A couple of points here:

1) What evidence other than mere assertion do you have that their balance sheet sucks? And please, before you present such evidence, define "suck" so we can judge - what may "suck" to you may not "suck" to me At this point, their percentage of delinquencies is not bad at all, as you noted above in your post. Hence the very article you quote seems to refute your assertion - at least at this point in time. Could it get bad - yes, the problem is no one knows right now where the bottom is. It's the uncertainty that's causing problems for them right now. I agree that their balance sheet MIGHT "suck" - it really depends on how bad the housing crisis gets.

2) The OP was talking as if we were going to be on the hook for their $5 trillion dollars in liabilities. As I pointed out, that's bogus since they were ignoring the balance sheet. And even it is weak, it is certainly not worthless. Hence the claim that we'd be facing a $5 trillion dollar bailout is still very much overstated and nothing you've said refutes that point.

The variation is that Freddie/Fannie are guarantors of the loans they've repackaged. That means Freddie/Fannie are ultimately on the hook for the mortgage crisis. That's bad, bad news.

I don't believe anyone here is denying this. The question is the size of the problem, and it's not a $5 trillion dollar problem - not even close.

And the $1 trillion dollar figure is waaay too high, unless you believe that 20% of the mortgages held by these two are going to go bad - which is an unheard of rate, and even more unlikely since they take only the best loans, not the worst ones.

The concern is whether there is a cascading effect from lower property values reducing the value of property, increasing interest rates causing more foreclosures, and the problem that it makes economic sense to walk away from properties with negative equity. A 10% failure isn't necessary because of the significant leverage which amplifies the economic pressure of more than usual rates foreclosures. And we're in a potentially historic situation. Bottom line, Fannie and Freddie horribly mispriced their risk and leverage amplifies the problem.

I think most of us here understand the potential problem, no one is disputing that. You seem to be arguing a point no one disagrees with. My entire disagreement was with the characterization of this as a $5 trillion dollar problem.

If it's true that accounting changes from FAS-140 are helping drive the crisis, that's unfortunate timing. But we've known since Enron that off-book balance sheets are bad news when a company has misjudged the market. While the cost might not be $1 trillion, the government has been expected to support Freddie/Fannie's guarantee of mortgage-backed securities under a less-than-conservative accounting system. That's not right no matter what the ultimate cost to taxpayers.

Right isn't the issue if it involves avoiding a depression or economic collapse. I doubt any politician would be able to say, "I did the right thing not bailing out those Freddie and Fannie" while the country wallows in a depression caused by that collapse.

[Zarathud]

Now this is the R&P you were waiting for.

Huh, you're forgetting something, along with the liabilities of over $5 trillion , they also have assets of over $5 trillion. Duh! You can't forget the other half of the balance sheet!

Except the other half of the balance sheet sucks. To use your example, the liabilities are constant (or increasing), and the value of the assets is decreasing. That's a weak balance sheet.

A couple of points here:

1) What evidence other than mere assertion do you have that their balance sheet sucks?

Perhaps you missed that whole home mortgage and mortgage-backed securities crisis that's been in the papers for months now. Fannie and Freddie guarantee those mortgages. From Fortune 7/10/08:

Former St. Louis Federal Reserve president William Poole tells Bloomberg that the firms are already insolvent and may need a bailout. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair-value accounting rules, Poole said.

We can argue whether changing the accounting rules is "fair" and how leverage should be reported on balance sheets, but let's look at the simplified current 2007 balance sheet before any accounting changes:

Most of the nearly $800 billion in assets held by Freddie as of the end of 2007 consisted of mortgage loans or securities based on mortgages. The company acquired the resources to buy these assets primarily by borrowing, with outstanding debt as of the end of 2007 of $738.6 billion. The key item on the liabilities side of the balance sheet is stockholders' equity, which represents the capital raised by Freddie through direct sales of stock and cumulative retained earnings. This equity provides a cushion against possible losses on any of its assets, in that the first $26.7 billion in losses would come out of the company's original capital, with creditors losing nothing. That cushion, however, would only cover losses that were less than 26.7/794.4 = 3.4% of the assets.

That's quite a thin cover given the amount of mortgages Freddie and Fannie were backing, increasing from 25% of outstanding residential mortgage debt in 1990 to 41.4% today.

2) The OP was talking as if we were going to be on the hook for their $5 trillion dollars in liabilities. As I pointed out, that's bogus since they were ignoring the balance sheet. And even it is weak, it is certainly not worthless.

My question isn't that there will a dollar-for-dollar bailout (that's worst case scenario), but there's turmoil any time an organization gets forced into bankruptcy. The risk is that the residential mortgage market FAILS when the organization guaranteeing 41.4% of the outstanding residential mortgage debt goes into bankruptcy even if the company's not totally worthless.

The question is the size of the problem, and it's not a $5 trillion dollar problem - not even close.

When the transmission falls off the car, is the question how much it's going to cost to fix? No. The immediate problem is that your car isn't going anywhere. I don't think arguing over the size is the appropriate question to debate.

Right isn't the issue if it involves avoiding a depression or economic collapse. I doubt any politician would be able to say, "I did the right thing not bailing out those Freddie and Fannie" while the country wallows in a depression caused by that collapse.

The real issue is the moral hazard from the failure to regulate while Freddie and Fannie were able to leverage at terms nearly as favorable as those for the Treasury itself based on the assumption that there would be Federal intervention. The market is already pricing the risk of government not intervening and the consequences to Fannie and Freddie, and pretty much freaking out after reassessing the risks associated with their business.

Almost all loans in this day and age are sold off to investors as securitized loans. And every company is moving them off their balance sheets as a result of that sale. FAS-140 is changing the gain on sale accounting that has been in place for 20+ years. These financial institutions have been operating above board in all of these transactions.

Leverage is a bitch, and Fannie and Freddie aren't selling them off entirely to investors since they're still guaranteeing the loans. The accounting rules of moving them off-book have allowed financial institutions to bury or fail to inform investors about the cascading effects of downside risks from heavily leveraged portfolios. The returns looked great when the market performed and you could assume the Federal government would intervene, but the cost was additional risk that wasn't obvious.

It's simply not accurate to portray Freddie and Fannie as "operating above board in all of these transactions" or innocent victims of an accounting rule change. Goverment regulators in 2004 discovered problems going back to 2001 with internal accounting controls and earnings manipulation, such as amortization, treatment of derivatives, and other structural problems resulting in an overstatement of earnings and an understatement of risk. Each company restated earnings -- Freddie by $5 billion and Fannie by $6.3 billion, with Fannie Mae paying a record $400 million civil fine in a settlement with OFHEO and the SEC.

Former U.S. Treasury Secretary argued at the time for additional regulation and claims that Fannie and Freddie were inappropriately operated under a hedge fund model. New regulation didn't happen, and instead the Bush administration had been recently relaxing some of the restrictions imposed after settlement of those $11.3 billion of accounting misstatements. Even the old rules failed to be sufficiently transparent to allow investors to be adequately informed of the real risks. You can't allow 40% of the mortgage market to essentially be backed like a hedge fund with systemic accounting problems, and implied government guarantees.

[The Preacher]

Almost all loans in this day and age are sold off to investors as securitized loans. And every company is moving them off their balance sheets as a result of that sale. FAS-140 is changing the gain on sale accounting that has been in place for 20+ years. These financial institutions have been operating above board in all of these transactions.

Leverage is a bitch, and Fannie and Freddie aren't selling them off entirely to investors since they're still guaranteeing the loans. The accounting rules of moving them off-book have allowed financial institutions to bury or fail to inform investors about the cascading effects of downside risks from heavily leveraged portfolios. The returns looked great when the market performed and you could assume the Federal government would intervene, but the cost was additional risk that wasn't obvious.

Perhaps you missed it where I said the change had merit. Or you ignored it. I'm guessing the latter because it didn't suit you. But, as I also said, you are being incredibly disingenuous to mislead others that this is anything but an arbitrary change and a change that dramatically impacts the way financial institutions are capitalized. You can't just cry "moral hazard" when we changed the rules midgame. While Fannie and Freddie have had their own miniscandals, those aren't particularly relevant to the issue at hand. This is FAS-140 fallout and we are causing them to fail by forcing this standard when financial institutions can absolutely least afford it. And the country can't really afford it either.

[Grifman]

Zarathud

All that is wonderful and much I agree with. But you jumped into a post where I was responding the the alleged size of the problem. If you want to talk about the other issues, that's great, but that's not the issue I was addressing. By saying the problem isn't a $5 trillion dollar problem I was in no way minimizing the other potential issues out there. That's all the point I was trying to make.

[pengo]

Let the free market sort this mess out, if you keep bailing people out then people will keep taking on more risk... I'm sorry but shit needs to hit the fan so people learn.

Buy gold...

[The Preacher]

Let the free market sort this mess out, if you keep bailing people out then people will keep taking on more risk... I'm sorry but shit needs to hit the fan so people learn.

I think the stockholders of Bear Sterns learned a pretty valuable lesson. What do you think Fannie's stockholders think? Freddie's? And that probably isn't the bottom.

I'm curious, what do you think will happen to the US and world economies if Fannie and Freddie collapse?

[pengo]

Let the free market sort this mess out, if you keep bailing people out then people will keep taking on more risk... I'm sorry but shit needs to hit the fan so people learn.

I think the stockholders of Bear Sterns learned a pretty valuable lesson. What do you think Fannie's stockholders think? Freddie's? And that probably isn't the bottom.

I'm curious, what do you think will happen to the US and world economies if Fannie and Freddie collapse?

No idea, but lets find out. I'm all cashed up . I doubt it will affect world economy's too much - there will be the usual panic, but we will continue on. I guess it depends on how a default of FM&FM will affect the real estate market and if that has a negative affect on any world banks that are exposed to the US real estate market.

I am a believer of letting the free market sort out this mess. I believe the whole market needs to learn what the consequences are when you take on too much risk and/or not factoring in risk. I think the generations that experienced the great depression have since left this earth. So who knows maybe we need a new one for everyone to learn why not to take on so much risk.

[Zarathud]

The problem is that Fannie and Freddie aren't participating in a free market and have been collaterializing their ties to government to reduce their costs of borrowing.

But you jumped into a post where I was responding the the alleged size of the problem.

Don't you have to call dibs on a thread or something? Point taken about the alleged size being overstated, but I think the accounting problems of Fannie and Freddie have really come home to roost. And after looking at the problem, I question whether it was smart to loosen the loan requirements on Freddie and Fannie since that's just allowed more questions about its portfolio balance.

Whoever is in charge of Freddie and Fannie hasn't done a good job in managing the mortgage market fallout -- if Bear Stearns failed with a $30 billion portfolio of bad loans, Freddie (with $800 billion) and Fannie were likely only surviving based on the market's expectation of a government bailout.

Perhaps you missed it where I said the change had merit. Or you ignored it. I'm guessing the latter because it didn't suit you.

I don't follow. Your point is confusing given your later argument that it was "arbitrary." The merit of the change acts to offset its arbitrariness.

But, as I also said, you are being incredibly disingenuous to mislead others that this is anything but an arbitrary change and a change that dramatically impacts the way financial institutions are capitalized. You can't just cry "moral hazard" when we changed the rules midgame. While Fannie and Freddie have had their own miniscandals, those aren't particularly relevant to the issue at hand.

I think we can agree that, to some degree, accounting rules like depreciation ratios are inherently arbitrary. But they're useful benchmarks, and I'd argue that the current rules appear to be more misleading than the changes.

When an organization can't follow the existing accounting rules, I think it is relevant. When a new, more conservative standard is imposed, there may be an optical illusion about the "worsening" of the situation. But I don't think the market views Fannie or Freddie as worsening because of accounting issues -- there's a recognition of risk from mortgage exposure that's no longer hidden under the moral hazard of government bailout.

My view is that the FAS-140 is trying to improve confidence by measuring against a more conservative standard -- and FAS-140 measures the degree of failure, rather than its "cause." The market pressure on Bear Stearns was going to hit Fannie and Freddie eventually. The only way out is for both GSEs to improve their balance sheets, and FAS-140 imposes a standard that the market hopefully will accept.

Note that the Fed just turned on the spigot, so Fannie and Freddie now have a way to come into compliance with FAS-140 at a 2.25% interest rate.

[Zarathud]

It's not a bailout yet in terms of spending taxpayer money, but just increasing the supply of money through government backed borrowing. Where does Uncle Sam get the money to lend? The printing press, of course.

The Fed said it granted the Federal Reserve Bank of New York authority to lend to the two companies "should such lending prove necessary." They would pay 2.25 percent for any borrowed funds -- the same rate given to commercial banks and big Wall Street firms.

The Fed said this should help the companies' ability to "promote the availability of home mortgage credit during a period of stress in financial markets."

Secretary Henry Paulson said the Treasury is seeking expedited authority from Congress to expand its current line of credit to the two companies and buy shares of the companies -- if needed.

[The Preacher]

Perhaps you missed it where I said the change had merit. Or you ignored it. I'm guessing the latter because it didn't suit you.

I don't follow. Your point is confusing given your later argument that it was "arbitrary." The merit of the change acts to offset its arbitrariness.

Merit and arbitrariness extend beyond balance sheet visibility. There's timing, who it impacts, etc. We could easily have continued along our current path without FAS-140 for the GSE's or we could delay FAS-140 until the housing crisis passed. This is not univariate analysis.

But, as I also said, you are being incredibly disingenuous to mislead others that this is anything but an arbitrary change and a change that dramatically impacts the way financial institutions are capitalized. You can't just cry "moral hazard" when we changed the rules midgame. While Fannie and Freddie have had their own miniscandals, those aren't particularly relevant to the issue at hand.

I think we can agree that, to some degree, accounting rules like depreciation ratios are inherently arbitrary. But they're useful benchmarks, and I'd argue that the current rules appear to be more misleading than the changes.

I don't disagree. But there is a consequence for those actions. In this case, most likely, a much tighter credit world. Good thing, bad thing, that's up for reasonable debate.

When an organization can't follow the existing accounting rules, I think it is relevant.

But you don't state why? How has that prior performance impacted today's issue?

When a new, more conservative standard is imposed, there may be an optical illusion about the "worsening" of the situation. But I don't think the market views Fannie or Freddie as worsening because of accounting issues -- there's a recognition of risk from mortgage exposure that's no longer hidden under the moral hazard of government bailout.

It's not an optical illusion when a company needs to increase its capitalization. That's very real. Furthermore, it is not a single issue. It is a compounding issue. Increased capitalization requirements * increased risk = multiplicative error.

My view is that the FAS-140 is trying to improve confidence by measuring against a more conservative standard -- and FAS-140 measures the degree of failure, rather than its "cause."

FAS-140 is not bad per se. And 5 years from now, it may improve confidence (although I tend to think that people will just figure out another way around it). But the result of bringing all those ABS back onto balance sheets is going to be painful.

The market pressure on Bear Stearns was going to hit Fannie and Freddie eventually.

Why and to what extent? They operated in totally different markets. Bear was subprime all the way, wrapping up a pile of shit and spraying perfume on it. From low FICO loans to NINJA's, it is hard to imagine a riskier portfolio.

Freddie and Fannie, on the other hand, were highly constrained: good FICO's, substantial downpayments, no jumbo loans. Certainly they were going to get clipped by the bullet. But what we're faced with is not a winging, but a potential headshot.

The only way out is for both GSEs to improve their balance sheets, and FAS-140 imposes a standard that the market hopefully will accept.

The market will accept it. But, as I said before, the question is what kind of fallout are you willing to accept to get there.

Note that the Fed just turned on the spigot, so Fannie and Freddie now have a way to come into compliance with FAS-140 at a 2.25% interest rate.

Today will be interesting but that is the secondary reason. We'll see if Freddie can place its $3B ABS today.

[pengo]

Wow, just wow.. This is just sickening: http://www.huffingtonpost.com/robert-l- ... 12940.html" target="_blank

Glad its not my tax dollars.

[The Preacher]

Wow, just wow.. This is just sickening: http://www.huffingtonpost.com/robert-l- ... 12940.html" target="_blank

Glad its not my tax dollars.

He's very right on many accounts. This is bankrolled socialism and has always been since FDR founded Fannie Mae as part of the New Deal. I mean, they aren't called Government Sponsored Enterprises for no reason. What he fails to talk about is the fact that while Wall Street has gotten huge profits with low risk (if you think this is a no-risk venture, take a look at their stock prices), the taxpayer has benefited likely just as much.

What I find interesting is that this fine liberal midn does not know whether he is hither or thither. Should we nationalize these institutions and continue to grease the wheels of home ownership but put the full risk of the GSE's upon taxpayers? Or should we eliminate them, as CATO would propose, and thus increase costs of lending to taxpayers but have it be relatively risk free to taxpayers? There is no easy answer here, despite this fine, fine gentleman's naive beliefs to the contrary.

[AWS260]

There is no easy answer here, despite this fine, fine gentleman's naive beliefs to the contrary.

Oh, he's not that attractive. "Rugged," maybe, but not "fine."

[Zarathud]

I believe the colloquial term is "right honorable gentleman."

[The Preacher]

Twin twisters -- The financial crisis claims another two victims—and once again the taxpayer picks up the pieces (The Economist)

If you cannot let firms fail in a bust, then you must contain them in the boom. That helps explain why the investment banks now need more supervision; why financial firms should have to hold more capital as a boom gathers pace; and why monetary policy should lean against rising asset prices. Regulation is necessary, but beware the state being seduced into taking on duties it cannot possibly carry out well. As Fannie and Freddie show, regulators are easily captured and outwitted. The best controls are transparency and competition. When possible the government needs to stand back. Sadly, it failed to do so in the American mortgage market.

[Dogstar]

And... here... we... go.

WASHINGTON - The government is expected to take over Fannie Mae and Freddie Mac as soon as this weekend in a monumental move designed to protect the mortgage market from the failure of the two companies, which together hold or guarantee half of the nation's mortgage debt, a person briefed on the matter said Friday night.

Some of the details of the intervention, which could cost taxpayers billions, were not yet available, but are expected to include the departure of Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron, according to the source, who asked not to be named because the plan was yet to be announced.

Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and James Lockhart, the companies' chief regulator, met Friday afternoon with the top executives from the mortgage companies and informed them of the government's plan to put the troubled companies into a conservatorship.

The news, first reported on The Wall Street Journal's Web site, came after stock markets closed. In after-hours trading Fannie Mae's shares plunged $1.54, or 22 percent, to $5.50. Freddie Mac's shares fell $1.06, or almost 21 percent, to $4.04. Common stock in the companies will be worth little to nothing after the government's actions.

The news also followed a report Friday by the Mortgage Bankers Association that more than 4 million American homeowners with a mortgage, a record 9 percent, were either behind on their payments or in foreclosure at the end of June.

That confirmed what investors saw in Fannie and Freddie's recent financial results: trouble in the mortgage market has shifted to homeowners who had solid credit but took out exotic loans with little or no proof of their income and assets.

Fannie Mae and Freddie Mac lost a combined $3.1 billion between April and June. Half of their credit losses came from these types of risky loans with ballooning monthly payments.

[Little Raven]

Ok, I can see why it's necessary for the government to back Freddie and Fannie's holdings.

But I sure hope they let the preferred stock go the way of the common stock. There's no reason to bail out the banks.

[The Preacher]

Ok, I can see why it's necessary for the government to back Freddie and Fannie's holdings.

But I sure hope they let the preferred stock go the way of the common stock. There's no reason to bail out the banks.

Well, preferred stock by definition gets preferential treatment over common stock (higher liquidation rights, guarantees on dividends, etc.). But I agree that they shouldn't treat them with any additional preference. From almost all accounts I've read, it sounds like they should just liquidate these guys.

[Austin]

And it's a go.One part of me says, good, it'll help (?) my portfolio a bit for a while. But really, I don't like it.

[Zarathud]

The Feds reviewed the books, and found things were worse than anticipated. Once again, it appears that Fannie Mae was involved in questionable accounting practices:

The takeover comes after more federal scrutiny found that Fannie Mae had been engaged in less-than-conservative accounting once again (it had serious accounting issues several years back) and following both Fannie and Freddie's increasing difficulties in raising capital in the mortgage markets.

That's completely unacceptable. Heads should roll.

[Austin]

Pre-market this morning WM is up almost 20% and WB around 15%. Actually even Goog, Cost and well... it's going to be a Green day on the market. But at what cost?

[Aganazer]

Another wonderful example of privatized gains and socialized loses.

[LawBeefaroni]

Pre-market this morning WM is up almost 20% and WB around 15%. Actually even Goog, Cost and well... it's going to be a Green day on the market. But at what cost?

It won't last. The cost might be worth it if it did, a few (maybe 10s) billion of taxpayer money for hundreds of billions of equity. But all it did was create a rally for sell offs. One could have made 50% buying FRE at the open around a buck and selling in the $1.50 range, where a lot of shares traded. For the most part though, the huge rallies just took anyone chasing up for a ride while the agile dumped or flipped. WM especially.

Rallies these days are just good times to sell.

Another wonderful example of privatized gains and socialized loses.

Yep.

[Austin]

WM especially.

Yes, although I'm in for a few this morning at ~$3.75 .