Posted on 03/01/2006 10:27:06 AM PST by ex-Texan
The issue so much isn't that there are problems, the issue is fear-mongers proclaiming they are going to fold and the economy is about to collapse. Fear-mongers have been talking about this pending collapse since the beginning of time and it is quite tiresome.
"Fannie's Funny Business"
February 24, 2006; Page A12
The stock market seemed relieved yesterday when Warren Rudman's 2,652-page report into Fannie Mae's accounting troubles didn't report major new discrepancies in the mortgage giant's books. That news was enough to put the stock up about 2% on the day after a nearly 4% rise Wednesday ahead of the report's release.
And we suppose it is good news of a sort that Fannie Mae's accounting restatement, for which the world has been waiting for more than a year, won't grow from the $10.8 billion figure already estimated. But $10.8 billion is big enough as it is; WorldCom's fraud came to "only" $11 billion. The report's main findings paint the picture of a company that routinely flouted both the rules and law. Some conclusions from the executive summary give a flavor:
• "[M]anagement's accounting practices in virtually all of the areas that we reviewed were not consistent with GAAP, and, in many areas, management was aware of the departures from GAAP" (emphasis added).
• "[E]mployees who occupied critical accounting, financial reporting, and audit functions at the Company were either unqualified for their positions, did not understand their roles, or failed to carry out their roles properly."
• "[T]he information that management provided to the Board of Directors with respect to accounting, financial reporting, and internal audit issues generally was incomplete and, at times, misleading."
• "[T]he Company's accounting systems were grossly inadequate."
The report also identified one case, in 1998, where earnings were manipulated specifically to meet a bonus target. That one instance was a doozy, however; a $199 million amortization expense that went unreported in order to make sure management got its lush payday.
If Fannie Mae were a normal private company, it would be tarred and feathered faster than you can say "Enron." But Fannie Mae is not just another private company. It has a federal charter and an implicit guarantee from the government (read: taxpayers) of its debt. Which makes it all the more vital that Congress reduce the risk that Fannie Mae and Freddie Mac pose to our financial system and the federal fisc.
One of the Rudman report's more worrisome findings was that Fannie's derivatives accounting was wrong because Fannie claimed that its hedges exactly matched its risk exposure when it did not. Fannie has long claimed it is capable of perfectly hedging the interest-rate and prepayment risks in its $800 billion portfolio of mortgage-backed securities. The Rudman report found that that often was not true. But the report only looked at the accounting issues posed by derivatives and hedging, so the public still knows precious little about the extent of the portfolio risk...
Nah, no risk there, nada, none, hunky-dory.
See my #143
You can not make a valid comparison between FNMA, which has most of its assets tied up in highly liquid securities and Worldcom, a communications company. Additionally, Rudman has no professional experience in finance. He has no business assessing portfolio risk, so why is the WSJ making an issue of it? Because, they have convinced themselves that there is more of a story here than there actually is.
It is a silly comparison. To a private company, $11 Billion is everything. 20 years ago, the S&L crisis hit the government for about $150 Billion.
This thread is a good example of why I typically avoid these threads.
The fact that no one seems to know anything about FNMA's balance sheet except a few outside people who declare it has a problem is not going to be on your radar screen.
Well, as they say in South Georgia, mamma never raised such an ignorant child.
Next time I want to know about FNMA or FHLMC I'll ping AR and presso. You two guys have an obvious inside track that commissions and editorial boards don't. I'll look forward to your reporting.
LOL!!
Aren't being very typical these days, eh? I notice that you don't post much during the day. FNMA keeps you guys busy doesn't she?
What's your interest here, FNMA finances all of your new homes?
I have no doubt there are problems, but the gloom and doom being pushed on these threads are beyond belief. There have been people on this forum predicting a total collapse of our economy since the beginning. It never happens. I have been laughing at these chicken littles for years. This is perhaps a $10 Billion problem in a $10 Trillion economy. Get a grip.
Not that I know of. I just love to watch chicken littles running around informing people how the sky is coming down.
AR I used to place agency (GSE) paper with accounts and regional dealers all across the Southeast. Here is a sample:
Step ups. The issuer guarantees to increase the interest rate paid on the bond every year. The bond becomes callable after the first year.
Range notes. The issuer guarantees a high rate of interest as long as interest rates stay in a range. If they move out of that range the rate on the bond goes to 2%.
Those are just two examples of the debt issued by FNMA and FRed.
I worked for a regional dealer my last two years in the bond business. I had an account that was a small life insurance company managed by an old man who had a deal to sell the company out to a larger company.
He bought about 4 million dollars of agency option paper for his company's balance sheet from a crooked firm out of Houston, TX. But the debt was all FHLB, (Federal Home Loan Bank). I saw it show up on the quarterly report. I called my trader and asked him to price it. He couldn't. As best I could tell it was worth about half of what the old guy paid for it the day after he bought it.
The deal fell through. The guy was about 80. Nice going huh?
Debt issued by our quasi governmental organizations so they can turn a mortgage facilition enterprise into a hedge fund and milk the golden goose. What a crock.
Even if their balance sheets are healthy they should be put out of business for fraud.
It was this agency optioned paper that buried Orange County California in 1994. Thanks FNMA, FCB, FHLB.
Man are you think-headed. For the last time, I don't claim to know what is going on with FNMA's balance sheet. If you had worked in institutional trading, you would know that such information is extremely proprietary. Even if you DID know someone who worked there, he could get fired for telling you about what type of bonds they were positioning. And the last person they would be showing their book to would be a reporter. They have nothing to gain from this. Suffice to say that they typically position highly liquid MBS, plain-vanilla sequentials, PACs and TACs. The toxic waste type classes are rarely even structured anymore (or actively traded), so there wouldn't be much opportunity to own them.
The Journal obviously has no idea what they are talking about because it is clear from their editorials that they don't even know what to look for or what to be concerned about. And, yes, I DEFINITELY know more about the GSEs and the CMO market than the Journal's editorial staff. It may surprise you to hear this, but I bet you probably do too. They are journalists, not gods. Get a grip.
Step ups and range notes are hardly hocus-pocus. The option is easily priced, and based on the prevailing interest rate enviornment at the time. They offer a higher current yield at settlement because the buyer is assuming the interest rate risk.
Your story is a fabrication. There are no Agency debentures that "lose 50% of their value." The principal is guaranteed. The bonds that might be able to do this are notional faced bonds (IOs). The GSEs do not sell these directly, they issue them through primary dealers (and they are more typically backed by mortgages, not the banks themselves). If your mythical octegenarian whale with his $4mm portfolio got burned, it was by the salesman at Coastal Securities, not the bank. Incidently, I probably know him too.
A bond with a 12 year maturity that has lost 50% of its value has to be reflected on an insurance company's balance sheet. Mark to market.
...snip...
"Fannie and Freddie are not ordinary companies. They have almost $1.5 trillion of debt outstanding, which they borrowed to buy and carry portfolios of mortgages and mortgage-backed securities; these portfolios expose both companies to enormous interest-rate and prepayment risk. To hedge this risk, Fannie and Freddie are parties to derivatives transactions with notional values in the trillions, in which the counterparties are some of the largest financial institutions; any failure of Fannie or Freddie to meet its obligations would expose these institutions to substantial losses. Fannie and Freddie debt is also held widely by banks and other financial institutions, in some cases accounting for more than 100% of their capital; a decline in the value of that debt would seriously weaken these organizations and reduce their capacity to lend.
"Finally, both companies are central to the real-estate financing market. If either of them could not function normally, that market -- amounting to almost a third of the economy -- would freeze up. As Alan Greenspan has pointed out for years, the risks inherent in the portfolios carried by Fannie and Freddie add up to huge systemic risk -- the danger that a failure at either company will spread to the economy as a whole.
"So here is the key difference between Enron and either Fannie or Freddie. Dishonesty or incompetence in Enron's management hurt shareholders and employees, both of whom could have protected themselves through diversification of investments. Dishonesty or incompetence in Fannie's or Freddie's managements could throw the economy into chaos, and from that catastrophe diversification provides no shelter. Faith in boards, audit committees, auditors and even regulators has been shown to be misplaced. Sure, Congress would likely come in and bail them out -- but immediately, without extended debate, and with trillions of taxpayer dollars potentially at risk? Not a chance. And the damage in the meantime would be devastating."
Thanks professor, but the only way such a bond could lose 50% of its original face value is (A) if he bought it at a premium (no dice, because the holder had received interest payments over time that made up at least some of the difference) or (B) it was an amortizing bond like an MBS (in which case the principal had already been returned to him, so also impossible). The outside range on high coupon premiums that the agencies sell is roughly 20%. Again, they DO issue amortizing IO's that can be called away with dramatic results, but they don't issue that product in small enough denominations for somebody with a $4mm portfolio. Therefore, it is simply not possible that your guy lost 50% of his capital. All callable debentures (including step-ups) have call schedules. They are called at a premium (ex $1.05), not par.
Wallison is off his nut. Like yourself he has no concrete examples of what might go wrong. He just makes a grim forcast of the aftermath. He cites prepaymant and interest rate risk as the primary threats, and then goes on to say that the companies have the risk hedged with notional faced derivatives. Well which is it?
this was a debenture not a mtg backed bond. It couldn't be priced. The market is OTC so it is very possible that it could (and probably did) lose half of its value if there were no buyers in the secondary.
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