Fannie and Freddie: Worth Negative $50 Billion Each

Fnm_fre_20080815233336Fascinating piece in Barron’s this week on our favorite junk paper: Phoney and Fraudy.

A few interesting factoids about the GSEs, many of which you may have been unaware of:

• In the "1980s Fannie was effectively insolvent";

• These two GSEs currently have $5.2 trillion debt and guarantee obligations;

• Both balance sheets contain a tax credit entry called "deferred tax assets." These increase Fannie’s net worth by $36 billion and Freddie’s by $28 billion. They don’t represent real cash, but are merely paper credits built up over the years. The worse shape the companies are in, the greater these credits are. To insolvent companies like FRE & FNM, they are meaningless accounting entries.

• The CEO claim that losses were due to being "forced to buy
higher-risk mortgages to meet government affordable-housing targets"

is provably untrue; The vast bulk of GSE losses came from mortgages where there was no attempt to
verify borrowers’ income or net worth. And, most of these mortgages were for principal balances much higher than mortgages made to low-income
borrowers;

• It was the lack of lending standards — LTV, Income verification, FICO scores, debt servicing abiloity, down payments, etc. — that was the primary cause of losses, and not a "soft" government goal;

• A substantial portion of Fannie’s and Freddie’s credit losses ($337 billion and $237 billion respectively) comes
from not sub-prime, but Alt-A. These mortgages were the real-estate speculation in the ex-urbs of Las Vegas and Los Angeles;

• Freddie CEO Syron has recently said they did not want to dilute current shareholders further;

Here’s your Ubiq-cerpt:™

"IT MAY BE CURTAINS SOON FOR THE MANAGEMENTS and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac . It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer’s dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies’ common stock, with preferred shareholders and even holders of the two entities’ $19 billion of subordinated debt also suffering losses. Barron’s first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"

Heaven knows, the two government-sponsored enterprises, or GSEs, both need resuscitation. Soaring mortgage delinquencies and foreclosures have led the companies to gush red ink for the past four quarters, and their managements concede the outlook is even grimmer well into next year. Shares of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) have lost around 90% of their value in the past year, with Fannie now trading at $7.91, and Freddie at $5.88.

Similarly, the balance sheets of both companies have been destroyed. On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie’s equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn’t much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.

What’s more, the fair-value figures reported by the companies may overstate the value of their assets significantly. By some calculations each company is around $50 billion in the hole. But more on that later…"

As previously noted, we covered our short in Fannie some time ago — but that was not an endorsement of either company. They simply had fallen far enough that we wanted to avoid the inevitable short squeeze.

The entire article is well worth the read . . .

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Source:
The Endgame Nears For Fannie and Freddie   
JONATHAN R. LAING   
Barron’s AUGUST 18, 2008   
http://online.barrons.com/article/SB121884860106946277.html

Free text version at Marketwatch

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What's been said:

Discussions found on the web:
  1. Bruce commented on Aug 16

    http://www.nytimes.com/2008/08/15/business/15norris.html

    “Not only are there more foreclosures, the losses are much larger. In 2005, Fannie lost an average of 7 per cent when it sold a forclosed property. So far this year, the figure is 26 per cent, and in California it is up to 40 per cent. In all of 2006 Fannie forclosed on 93 homes. The current rate is 1000 per MONTH.”

    From the weekend edition of the NYT.

    Bruce in Tennessee

  2. John Borchers commented on Aug 16

    It’s an excellent time to be a new bankin the US.

    If a bank IPO came out I would buy it. I wouldn’t touch anything else financial right now cause they all are holding junk and don’t know it; including Goldman.

  3. ardano commented on Aug 16

    Dear Fellow BP Readers: It has been a death watch for fnm and fre. For some time now, the word on the street is that some federal bail-out will be required wiping out equity. Bill Gross has been talking his book on this subject any chance he gets. However, other than Bill Miller, who else is buying fnm and/or fre down here? If Miller’s right, this will be an incredible call. I’m a daily reader of this service and assume my fellow readers are smarter than me. In this battle of the Bill’s who is right?

  4. John commented on Aug 16

    They should have nationalized them when they announced the bailout. The reasons they didn’t were basically political and political/economic.

    Political: they didn’t want mount a huge nationalization on Bush’s watch.

    Political/economic: It would have required their obligations of something over 5 trillion to be added to the national debt and it’s hard to say whether the long term political or economic fallout would have been greater.

    Nationalization or pumping money into them which amounts to the same thing is inevitable. Bush is desperately hoping he can kick this can down the road, boy he’s sure got a lot of cans to kick, but I smell a crisis looming of which this article is a symptom. It’s going to be read around the world, a thousand analysts are going to start scanning their numbers, shorters will start moving back in, and the inevitable will follow.

    I do however, disagree with the consensus from Greenspan to the author of this piece, and Barry?, that it will be viable in the context of US housing finance to split them up and sell them off to private companies. Of course it can be done but their functions are a necessary lubricant of the US housing market and if you privatize them two things are going to happen. Firstly, availability and cost of housing finance are both going to be impacted with a consequent chilling effect on the US housing market. Whether that’s good or bad I’ll leave others to decide but a blow will have been struck at one of the principal long term drivers of the US economy. Secondly, the next time a financial crisis blows up housing finance availability is going to be dramatically curtailed. Rather as is now happening in the student loan market. For these reasons plus the fact that congress and the admin will have a whole new field of control and patronage I’d say the odds are they will never be privatized but will continue to function as now as public corporations.

  5. techy commented on Aug 16

    john..

    i agree with you…even though those two entities should not be bailed out with tax payers money….they are too big to fail given the current condition of economy.

    in other words only way to avoid great depression is somehow get the housing market back to normal. (maybe after another 15% fall in home prices making them affordable).

    if the mortgage market gets frozen due to the privatization of fraudy and foney, we will see the biggest blood bath in housing market, financials, equity market etc…

    which will definitely lead to many companies defaulting due to tight credit markets…and that will lead to chain reaction causing layoffs..

    in other words a wet dream for the bears…

    but bad news for american middle class…so it wont happen no matter what the moral hazard is.

  6. AB commented on Aug 16

    Barry:

    thought that you dissed any analysis from Johnathan Laing..

    Here is an excerpt from your recent post.
    “Maybe he (Johnathan Laing) has an ability to see what others miss. How has his track record been in making these articles forecasting improvements in weak companies or sectors?
    Short Answer: Not so good”
    bigpicture.typepad.com/comments/2008/07/barrons-cover-g.html

    ~~~

    BR : His falling knife catches are clearly not any good.

  7. larster commented on Aug 16

    If the consensus is that the Fed (or should I say we) has to pump money into Fannie and Freddie, which is really nationalization, then how do you privatize them? If any financial entity had the werewithal to buy one of them, the mortgage market would not be flat on it’s ass right now. Who would of thunk that the gov would not only be in the mortgage business but perhaps the largest or only player.

  8. Mark E Hoffer commented on Aug 16

    speaking of Bill Gross of Pim(P)co, I thought it was interesting that he, fairly recently, began selling his Stamp Collection–previously, one of the World’s largest privately-owned accumulations..

    http://www.glenstephens.com/snaugust07.html

    “Discovered key to making money with bonds: trade, don’t buy and hold.”
    http://www.forbes.com/lists/2008/10/billionaires08_William-Gross_3ESQ.html

    how does he reconcile the fact that many of his funds’ customers are in his funds-buy&die style- while he, obviously, knows differently/better?

    and/or how did he get so long FNM/FRE paper in an era, that he shows he understands, where paper/credit assets were declining, relatively, in value?

    I haven’t seen him, on the record, recommend shorting his paper fundz..

  9. touche commented on Aug 16

    The housing market doesn’t need F&F. They should be sent into runoff mode with no govt bailout, and then new agencies could be created with more oversight. The bagholders received a higher rate than treasuries to compensate for greater risk, so now its time to pay the piper.

  10. Mr Bubbles commented on Aug 16

    Karl Denninger at Market Ticker had an interesting piece Aug, 8 on the GSEs:

    He mentioned a study that was published by The Fed in 2005 looked at the impact of the GSEs on the mortgage market.

    http://www.federalreserve.gov/pubs/feds/2005/200505/200505pap.pdf

    Look at the chart at the bottom of page 25.

    It makes quite clear that the largest beneficiary of Fannie and Freddie’s existence has been Fannie and Freddie themselves – that is, their shareholders, employees and executives – and not homeowners.

    According to the Fed study, the impact of having the GSEs in the market has been a “whopping” improvement in your interest rate of 0.04 to 0.12%!

    That’s right, four to twelve basis points.

    The claim that the GSE’s have been of “tremendous benefit” to the American Homeowner is a whopping LIE, perpetuated by Congress who wants you to think they’ve done you a huge favor over the years.

  11. RK commented on Aug 16

    Um, weren’t “deferred tax assets” what GM wrote down by 39 Billion
    recently? (because there was no prospect of income to use them against in forseeable future)
    On the subject of “screw the GSE debt bagholders”, be careful what you wish for. It’s China, the Gulf and Russia et al who keep
    providing “everyday low prices” for the money we borrow for just about everything. Satyajit Das isn’t sure how long these strangers
    kindness may last. Best not antagonize them.

  12. DeDude commented on Aug 17

    Without F&F there would be no housing market in the US today. The fact that it is still possible to sell a house to someone that cannot pay in full with cash is only due to the fact that we have F&F. The free market has, as usual, failed miserably when the pressure was on. What is needed is not to give the housing market back to those who failed to service it responsibly, but to natinalize F&F so they no longer get the idea that they should put higher priority on serving their shareholders than on serving the country. And then we need a complete revision of how houses are sold and financed. All the people making the risk and profits in that market should be legally liable for some of the loss if a loan fails within the first 5 years. There have to be incentives to act responsible not just incentives to sell at highest possible price regardless.

  13. Greg0658 commented on Aug 17

    I’m with you DeDude

    and larster – “If any financial entity had the werewithal to buy one of them …. and Who would of thunk that the gov would not only be in the mortgage business but perhaps the largest or only player”

    the vultures are out there – just waiting for the MSM to do the “March into Iraq” trick on Fan & Fred

    pennies on the dollar repossions is The Play

    man against man / industry against industry

  14. Tom C commented on Aug 17

    So, ALT-A loans are not ‘higher risk mortgages?’ Why would an agency with implied backing of the government/taxpayer be buying such things? When did they begin buying them and why? Alt-A loans occupy the grey are between prime and sub-prime. They are performing more like sub-prime at the present time. Where were OFHEO and their congressional overseers?

  15. Chester White commented on Aug 17

    As noted above, Bill Gross is a stamp collector, as am I. I got the chance to see some of his collection and it was truly amazing.

    That $9,000,000 Great Britain collection was the tip of the iceberg. He’s spent over $50,000,000 on stamps; here’s Gross on the investing angle:

    ” ‘It’s beyond my expectations,’ Gross said of the GB Auction result to Bloomberg’s. ‘It’s four times profit. It is better than the stock market.'”

    If you are a collector of anything, to see much of the best stuff all in one place is a real treat.

    A book was published of part of his award-winning collection:

    “The William H. Gross Collection – United States Classics, 1847-1869”

  16. leftback45 commented on Aug 17

    Tom C – Alt-A is MUCH WORSE than sub-prime. Defaults may be HIGHER and the loans are BIGGER, these are the ‘stated income’ people and they will walk away. BTW,for those who think that Prime MBS are OK, some of those Prime Loans will not look so Prime when unemployment bites and the high end of the market crumbles. This happened in Japan and it was not pretty……….

  17. DeDude commented on Aug 17

    F&F was pushed into the rotten part of the mortgages business by the same free market forces that got the other financial institutions into them. There was a lot more money in it than in normal mortgages, and when other institutions started harvesting fat profits from this ALT-A stuff the shareholders of F&F started complaining that they did’nt get a fat piece of that pie too. The CEO’s also wanted the extra profit so their bonuses could be good and fat. Combine that with regulators who where told by their bosses that free markets are always better than government intervention – and you have a disaster that had to happen. This is yet another privatization scam courtesy of the neo-con-men, like the supply trucks in Iraq being driven by young men payed $500/day by private contractors rather than by soldiers payed $50/day – because their ideology tells them that private industry is so much more cost efficient than government (and we would not want reality to get in the way of ideology – would we?).

  18. rj commented on Aug 18

    “Without F&F there would be no housing market in the US today.”

    You lost credibility at this statement.

    Yeah, no one would ever be able to buy or sell a house again.

  19. Kay commented on Aug 28

    Well, I’m totally confused. The past few days have seen FNM and FRE taking off. Is this because of big hedge funds or just day traders trying to get a few extra dollars to pay for gas this Labor Day weekend? Jim Cramer is barking about insider trading causing both stocks to go higher and this should be stopped. I thought both stocks were in a death spiral only to resurrect of late. Bail out or no? It sounds like Not during the present administration. Heh, if someone other than big hedge fund managers are able to make a few extra dollars while the government (or rather the new administration following the election)is stalling on bail out or dissolving FNM and FRE then great.

Read this next.

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