Are Fannie and Freddie going to need a bailout?

Felix Salmon is one of those people who do not think that the busting of real estate bubble is going to amount to anything. In this post he rips into a New York Times article that suggests that a crisis looms in the market for mortgages. Most of Felix’s gripe against the New York Time’s article revolves around something that I still don’t understand very well. Namely, the market for subprime MBSs.

But notwithstanding my ignorance, I still have to wonder what Felix was thinking when he said this…..

Morgenson also talks at great length about the enormity of the market in MBSs, but never stops to point out that the vast majority of that market is in bonds issued by Fannie Mae and Freddie Mac, and that no one has any worries whatsoever about those securities crashing.

Um…..

Is Bernake somebody? This just in from the CNN News…..

“The size and the potentially rapid growth of GSE portfolios, combined with the lack of market discipline faced by GSEs, raise substantial systemic risk concerns,” Bernanke said via satellite to a banking conference in Hawaii.

Is Greenspan somebody?

This is Greenspan in 2005……

“The strong belief of investors in the implicit government backing of the GSEs does not by itself create problems of safety and soundness for the GSEs but it does create systemic risks for the U.S. financial system as the GSEs become very large,” he said.

I don’t know much, but I am pretty confident that saying that nobody has any worries about Fannie Mae and Freddie Mac’s securities is a big stretch. To give you an idea of how vulnerable Fannie Mae and Freddie Mac are consider this quote from Martin Hutchinson….

However there’s a snag here, and that’s Fannie and Freddie. With $3.8 trillion of the $10.7 trillion of home mortgages, they should suffer $350 billion of losses. Since they have an upper mortgage amount limit of $417,000, they will have fewer loans on the coasts than average, and fewer loans against grossly overpriced McMansions than average. They may also have fewer sub-prime loans than average, though they have been active in negative amortization rubbish. Thus their losses may be lower than average, perhaps only $250 billion.

However, there’s a snag here. Fannie and Freddie’s combined capital is only $79 billion. That means they are almost certain to default, and to require bailout by the long-suffering U.S. taxpayer. The one consolation will be that their losses on inappropriately hedged interest rate risk on their $1.4 trillion of directly owned mortgages, about which Bernanke was concerned, will be dwarfed by their simple credit losses on their guaranteed mortgages as a whole.

Ignore Hutchinson’s estimates of how much Fannie and Freddie stand to lose if you want to. The point is that losing less than 5% of the money that Fannie and Freddie have guaranteed in mortgages market will destroy their entire capital and then some. Loses on that scale don’t strike me as at all that inconceivable given the scale of the problems in the real estate market. If they did suffer losses on that scale, how will they make payments on those bonds that Felix says that nobody has any worries about whatsoever?

Of course, Fannie and Freddie have an implicit government guarantee so they will probably get bailed out.

But I don’t think that was Felix’s point. I gather that he does not think that the woes affecting the subprime market are going to have any significant effect on Fannie and Freddie. To my mind, that is a very dubious proposition.

Maybe I am revealing my ignorance again, but wasn’t the whole point of Fannie and Freddie to make housing more affordable for lower income people? Does that not imply that the problems that are infecting the subprime market will also affect them?

One Response to “Are Fannie and Freddie going to need a bailout?”

  1. […] _uacct = “UA-1202685-1”; urchinTracker(); Map of the Ethereal Land The Ethereal Voice Front Page – Politics – Money – Knowledge – Art – Food – Fun Masthead About Are Fannie and Freddie going to need a bailout? By Ape Man | March 12, 2007 – 6:24 pm Posted in Category: Money Felix Salmon is one of those people who do not think that the busting of real estate bubble is going to amount to anything. In this post he rips into a New York Times article that suggests that a crisis looms in the market for mortgages. Most of Felix’s gripe against the New York Time’s Click Here to continue reading. […]

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