Reuters Wire Reporting: US Attorneys Confirm Criminal Investigation At Freddie Mac

6/11/03

[presidio9]

Developing...

[presidio9]

Shares of Freddie Mac (NYSE:FRE - news) fell in pre-open trade after The Washington Post reported on Wednesday federal prosecutors have opened a criminal probe of the No. 2 U.S. home mortgage financier.

Freddie Mac, which ousted its top management on Monday over an earnings restatement going back to 2000, also faces a U.S. Securities and Exchange Commission (news - web sites) probe and congressional inquiries.

[AAABEST]

This could become a problem.

Yeah "the Fed won't let our real estate financing system crash" as some say, but for every action there's a reaction.

[flamefront]

From Malkin, N.B.:

CLINTON APPOINTEES Political appointees to the companies' boards pocket millions in stock options to bolster support on Capitol Hill. Clinton-appointed board members at Fannie Mae include Marc Rich's lawyer Jack Quinn, and Janet Reno's lieutenant at the Justice Department, Jamie Gorelick. At the helm of Fannie Mae is another Clinton appointee, Franklin Raines, who was paid more than $4 million and had almost $6 million in unexercised stock options in his first year at the helm. Cheerleaders in both major political parties have opposed privatizing Fannie and Freddie.

Start looking back at how this is another manipulated S&L debacle.

The leftists do want economic failure, right?

[Hans]

The great question is whether it is just lying, to be expected in a post Clinton world or
have we stumbled on a nest of thieves.

[presidio9]

Having spent a lot of my career dealing with Freddie, I can say that a lot of their problems are based on perception. Freddie securitizes home mortgages, turning them into bonds. They sell "corporate" debt to finance this operation. They then position the mortgage backed securities against the "corporate" bonds (known as "agencies") they are selling. Both mortgage backed securities and agencies are technically "derivatives." For casual followers of finance, "derivatives" is a very scary word. But there are "derivatives," and then there are derivatives. When I was dealing with Freddie Mac, they only got involved in the most plain-vanilla of derivatives. But just try telling that to a congress that has been scared out of its wits by months and years of fear-mongering by reporters who don't really understand the business.

The worst thing about this is that this new knews has already widened credit spreads on Freddie products, which has a large negative effect on Freddie's balance sheet. This whole story is a self-fufilling prophesy.

[FreePaul]

Sounds like just more continuing criminal enterprise called government. Real news would be finding a government enterprise staffed by honest people who aren't stealing taxpayers money.

[ken5050]

If it's problems at Freddie, can FannieMae be far behind?

[Gunslingr3]

The worst thing about this is that this new knews has already widened credit spreads on Freddie products, which has a large negative effect on Freddie's balance sheet. This whole story is a self-fufilling prophesy.

I think 'self-fulfilling prophesy' is the wrong way to look at it. It's an expectable outcome. Three honchos get fired or resign, one of them for apparently forging documents (diary) used in an investigation and they announce they're going to restate three years of earnings. If that doesn't justifiably cause people to at least consider the risk associated with the enterprise, what would?

[AAABEST]

Having spent a lot of my career dealing with Freddie ....

My guess is you're in the securities business in some fashion. I dealt with Freddy at the "street" level as I did RE finance a while back.

You're right about perception. Freddy and Fannie were always perceived to be as solid as stone, the source of all of our "A" paper (frankly you often can make more money and accomodate the customer better with "B" paper, but that's another story).

If it turns out that our perception is wrong and they're not really as solid as perceived, it most certainly will have a detrimental effect.

The nice thing about being in real estate is that you never really lose. In other words, if events such as this leads to a housing crunch, well that may mean that those of us looking to buy won't get the deals we're after, but our existing real property goes up in value.

That's why they call it "real" property, unlike stocks which in my opinion are for either wiping your ass or at best for long term slow gain.

[presidio9]

I will tell you that Franklin Raines is a Clinton affirmative-action appointee, and he makes $4mm a year at Fannie for doing nothing, but for the most part the traders and risk managers at Freddie and Fannie are overqualified for the difficulty of their job. Managing Freddie's portfolio is not rocket science. It is not much more difficult than balancing a checkbook.

[CatoRenasci]

I agree that in my experience Freddie Mac has done pretty defensible derivatives, although any significant change in default rates (who knows if the experience after '87 will be repeated) could change the quality - wiping out the C pieces (no problem because those are inherently speculative and have taken a hit with all the low interest rate refinancing anyway), but also eating into the B's and, worst case, into the A pieces.

I have always been more than a little nervous, however, at the way Freddie Mac and Ginnie Mae are run, as secretively as a privately held company almost. Any bad atmospherics will increase Freddies cost of borrowing, which will rachet up rates to real estate borrowers. In the current market, that's bad: as we see the highest end markets in Fairfield County, Connecticut, there are plenty of buyers, and lots of inventory, but no urgency to buy. Prices are still close to last year's overheated peaks. Choice properties still command premiums, but average houses in each price category (other than the lowest - under $750,000) are very price sensitive.

[Glenn]

But just try telling that to a congress that has been scared out of its wits by months and years of fear-mongering by reporters who don't really understand the business.

I'd hardly say the Wall Street Journal could, in any way, be classified as you've described here. Were it not for their constant pressure for more accountability from Freddie and Fannie, these truths -- no matter their risk or result-- would not have seen the light of day.

[presidio9]

That's my point. The questions do not need to be asked, and are going to cause a lot more trouble than they hop to resolve.

[Glenn]

The questions do not need to be asked, and are going to cause a lot more trouble than they hop to resolve.

I'm not following you here. Let sleeping dogs lie? Don't inquire into possible wrongdoing because you may wind up with an Enron on your hands or, perhaps, nothing wrong at all?

Oversight is required. I would argue that oversight by morons is worse than no oversight at all, however. Get a qualified panel to look through the books and give America a straight answer, since America is on the hook for this thing.

[AdamSelene235]

The worst thing about this is that this new knews has already widened credit spreads on Freddie products, which has a large negative effect on Freddie's balance sheet. This whole story is a self-fufilling prophesy.

Its called a positive feedback loop. Some are stable, other are not. This one is not.

Director Armando Falcon Jr., upon his resignation from the Office of Federal Housing Enterprise Oversight: (Helpful hint: by the time a career bureaucrat admits you have problem, you really really have a problem. Over the past quarter-century, financial markets in many countries have experienced serious disturbances associated with financial institutions and failures. The period has been one of profound and rapid changes in the financial sector. Those events have heightened awareness of systemic risk - the possibility that a systemic event, a financial crisis that leads to a substantial reduction in aggregate economic activity - will occur… Recent analyses of systemic risk have concluded that some non-bank financial institutions are now so large and integral to the financial sector as a whole that their failure could lead to a systemic event. Fannie Mae and Freddie Mac - the two government-sponsored enterprises (GSEs) chartered by the federal government to support the secondary market for residential mortgages - are among the largest non-bank financial institutions in the world. Thoughtful observers have expressed concern that, if either of those Enterprises experienced severe financial difficulties, turmoil in the market for GSE debt could become severe and spread to other financial markets, substantially increasing systemic risk… Fannie Mae and Freddie Mac are each among the largest end-users of financial derivatives. To date virtually all of the derivatives contracts of Fannie Mae, and most of those of Freddie Mac, have been over-the-counter (OTC) contracts, primarily interest rate swaps and swaptions - options to enter into interest rate swaps… The Enterprises enter into foreign currency swaps to fully hedge the exchange-rate risk associated with issuing foreign currency-denominated debt… In volatile markets such as those associated with the Asian currency crisis of 1997 and the Russian default of 1998 - the latter associated with the collapse of Long Term Capital Management - the market values of some derivatives contracts may fluctuate significantly and even be difficult to determine, especially where markets cease to function normally and model-based valuations, which assume liquidity, become invalid… The market for OTC derivatives is highly concentrated among a small number of dealers, primarily brokerage firms and commercial banks that are counterparties for at least one side of virtually all contracts. The largest dealers include JPMorgan Chase, Citigroup (including the large derivative operation in its broker/dealer subsidiary, Salomon Smith Barney), Deutsche Bank, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley Dean Witter… (Total notional value of Fannie and Freddie derivatives at year-end 2001 was $1.19 Trillion)

St. Louis Federal Reserve Bank President William Poole:

"Should either firm be rocked by a mistake or by an unforecastable shock, in the absence of robust contingency arrangements the result could be a crisis in U.S. financial markets that would inflict considerable damage on the housing industry and the U.S. economy,"

"A market crisis could become acute in a matter of days, or even hours,"

[AdamSelene235]

Big Scary Monsters - Fannie Mae article
http://www.economist.com/finance/displayStory.cfm?Story_ID=702604

Systemic Risk: Fannie Mae and Freddie Mac and The Role of OFHEO
http://www.ofheo.gov/docs/reports/sysrisk.pdf

Fannie, Freddie Regulator Releases Study, Resigns

Fannie Mae Enron?

Mortgage Buyer Fannie Mae's Fourth-Quarter Profit Hurt by Massive Derivative Losses

Derivative Mkts Register Concern Over JPM And Fannie Mae

THE MOUNTING CASE FOR PRIVATIZING FANNIE MAE AND FREDDIE MAC

[junta]

There won't be, but it will get a Fed led papering if the need arises and their short term borrowing gets too expensive for their long term bulls#$%^ job on the public.
There is at least one more moral hazard card left to be played and that is the direct printing press to debt holder joker card (of course dressed up in arcane finance speak). America's finances from top to bottom are more akin to a dying man's hot hand at the craps table, "Let her roll baby I got nothin to lose."

[SierraWasp]

"...unlike stocks which in my opinion are for either wiping your ass or at best for long term slow gain."

My goodness!!!

I've finally met someone on here who's just as opinionated, crass and as crude as the ol Waspman!!! (grin)

BTW, Ernesto, this is the situation you were asking me about just the other day... now it's developing.

[presidio9]

This is what I'm talking about. I am not advocating "letting sleeping dogs lie." What I disagree with is the irresponsibility of reporters who have demonstrated that they do not really understand how the GSEs operate. All they know is that a lot of money passes through them, and what they do appears to be complicated. So that has to be a story right? Hold on a minute. I would be the first to advocate the removal of Clinton Administration appointees who are asleep at the wheel. But tying their incompetance to speculation that the GSEs make all their money through unhealthy "derivatives" speculation, or that if home mortage defaults go up these companies will be in crisis and that the effect on the economy will be worse than the S&L scandal is not just irresponsible, it is malicious. The GSEs exposure to defaults is and always has been minimal. The loans they securitize are pre-screened to conform to a higher standard.
Fannie and Freddie have much greater exposure to public perception. And that is where the story becomes troubling. Regardless of thier superior credit quality, thier product still trades on a relative-value basis. Their positions are negatively impacted by this fear-mongering type of reporting.