Are Fannie Mae And Freddie Mac Now Liabilities?
September 23, 2002
Fannie Mae and Freddie Mac are government-sponsored corporations whose purpose was to create a liquid secondary mortgage market. Supposedly, their core business is the fees they get from guaranteeing principal and interest on the mortgages they securitize. That market is now big enough and deep enough to prosper without them. Nor does buying securities lower interest rates since the companies must borrow to finance their buying.
However, the profits from their mortgage portfolios dwarf the profits they earn from securitizing mortgages. And to purchase mortgages, they have gone deeply in debt.
- Currently the pair each hold more than 30 percent of their own mortgage-backed securities outstanding.
- In addition they hold nearly 7 percent of each other's securities, requiring them to issue more than a trillion dollars of debt.
- Moreover, Fannie and Fred must hedge against the risk of falling interest rates for a trillion-plus dollars of mortgage securities.
Fannie and Fred purchase mortgage-backed securities to boost earnings. Both can borrow cheaply because of their implicit backing by the government -- and therefore taxpayers. They profit by the spread between their lower cost of borrowing and the higher interest rates on the mortgage-backed securities.
However, falling interest rates have encouraged a record number of home refinancings and therefore of mortgage prepayments. Thus Fannie's assets are being paid off faster than expected by homeowners. To acquire more assets, they have to increase borrowing, exposing taxpayers to higher and unnecessary risks.
But despite increasingly skeptical markets post-Enron, Fannie doesn't disclose much about its financial operations. The Wall Street Journal suggests a solution: Fannie (and her brother, Freddie Mac) should be forbidden to buy mortgage-backed securities.
Source: Editorial, "Fannie Mae's Risky Business," Wall Street Journal, September 23, 2002.
For WSJ text (requires subscription)
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