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

Associated Press ^ | 1-15-02 | Associated Press

[groanup]

"So please help me understand what you are calling the "black ops" for pumping money into that environment.

What's "black" about it, or are you looking at a component that is outside of my limited view?"

You should see the c**p that FNMA issues for debt. Some of the stuff can only be described as toxic waste. They issue this stuff with a gazillion imbedded options that favor FNMA. Orange County bought this mincemeat and went belly up. It's a mammoth hedge fund with an implied government guarantee. They issue this stuff and then re-invest in off balance sheet derivatives using leverage and on balance sheet futures and options with only a slight nod to investing in mortgages (so children can have a nice home).

[Liz]

An accounting change, which took effect in 2001, requires companies to record changes in the market value of all derivatives even if they aren't sold.

FASB's 2001 proposal went into effect June 2002.

The rule required corporations to label an instrument equity only if they could demonstrate an "ownership relationship." If a derivative's value moves in the opposite direction of a corporation's stock price - as many do - it would be considered a liability, even if the contract is ultimately settled in stock.

The big boys went ballistic figuring the FASB change would make some derivatives much less palatable b/c it would force companies to account for them as liabilities. Switching to a liability classification would make quarterly earnings results more volatile.

The concept behind FASB's proposal was to provide shareholders with a clearer view of the value of derivatives that corporations hold.

As they say, the road to financial insecurity is paved with good intentions.

[Southack]

I still can't see your justification for thinking that FNM is going to go down for the count.

She's only got a 13 to 1 P/E, hardly the stuff of stock market bubbles. Even in bad years when interest rates get jacked down (triggering waves of refinancing at lower margins), she still manages to make more than a Billion bucks a quarter (net!).

Moreover, every dime that she loans out is backed first by a unique homebuyer, second by several forms of home and mortgage insurance, third by a form of additional insurance on whatever "package" of loans the mortgage in question was sold inside, fourth by the actual house itself (a real, tangible asset that can be repossessed and resold or rented), and fifth by the full faith and credit of the U.S. government (an entity that just happens to have the largest economy in all of this planet's history, as well as the most powerful military to ever tread on soveriegn soil).

So how does that entire structure fail? The homeowner has to first lose her ability to pay, then all of the various forms and both levels of insurance have to fail, then the resale and rental angles have to cave, then the U.S. government has to be unable to rescue the situation via financial, legislative, or military means.

Surely there is a stock out there with a little bit higher P/E ratio and a much lower tier of hard assets, insurance, cash flow, and government backing that you could Short with some degree better chance for your own eventual success!

[Southack]

One more thing, although I don't have the figure in front of me, I'm under the impression that roughly half of all homebuyers own MORE total assets than the remaining balance on their home mortgage loans, even when you omit the entire value of the house.

If that's an accurate statement, then the pool of people who could default without consequence is reasonably limited, even if you were in an environment in which no house was worth more than a Dollar.

Thus, unless I'm really missing some key fact, getting to a point wherein real financial catastophe of previously unheard of proportions was realistic - just doesn't seem to be in the cards to me.

[imawit]

You're quite possibly right about Cave's resignation. I said this earlier and I'll say it again, the problem they never foresaw was this low an interest rate for this long a time and with the Feds & Treasury in full battle op to keep it low.

I don't care how they did their derivitives, no one is going to guarantee losses due to low yielding financial instruments. That's like saying if treasury bonds go below 10% I will make up any difference 1 to 1 for that margin below 10%. No body has that kind of money !

Maybe that's what did happen and the counterparty just got totally looted. What I see is that Cave has confronted the wall & seen the handwriting on it.

Typically derivitives were set up to play off the nonperforming mtgs not indemnify ones portfolio losses due to JUNK financial vehicles. This no one foresaw as well as the battle against deflation that Greenspan & the Treasury are waging.

It's just a big squeeze in yields a la Treasuries at the moment and there is no let up in sight.

Another factor is that the mtgs that have been packaged by the GSE's still have to be serviced and that servicing is done by the BIG three, BofA, Wells and WAMU (Washington Mutual). Their contracts are set and this expense is set for now but can only rise (staff, plant, and additional of both to handle the mtg turnover).

GSE's just don't have an attractive vehicle at the moment and they are stuck with the bed they have made for themselves. They have to buy mtgs and package them into securities to sell on Wall Street. Wall Street may not want to buy them any more if the yield is going down and therefore the price of stocks must go down accordingly. Or maybe the Feds will monetize and pump GSE's shares also.

Once monetized mtgs have been sold, that pooled money is again made available to Mtg Banks to make new loans and the GSE's are not able or allowed to do anything with that like invest it in order to earn more money to boost their earnings.

GSE earnings will continue to fall. It's automatic with what the Feds and the Treasury are doing. It's nowhere near or remotely related to derivitives. And the mechanisms are in the GSE's charter, their charter of existence & purpose which is set in CONCRETE. At the moment any way.

Who know's, they could go belly up and then the servicers, BofA, Wells & WAMU could buy up the mtgs they're servicing for pennies on the dollar and the US Government would make good on the difference to all of the GSE's shareholders. Not a pretty sight and the tax payers would foot the bill. This exact scenario happened with S & L's just 10yrs ago.

[imawit]

Oh, forgot ... and the conflict between OFHEO and the Treasury's statements?

I think this conflict is just the sparing phase to set someone up for the fall. They bought some time by camouflaging what's really going on by using derivitives as the "WHY". No one understands this enough to say anything other than "Oh is that it, OK".

[AdamSelene235]

She's only got a 13 to 1 P/E, hardly the stuff of stock market bubbles.

Earnings just dropped 50%. Given the current levels of leverage P/E is meaningless.

Moreover, every dime that she loans out is backed first by a unique homebuyer, second by several forms of home and mortgage insurance, third by a form of additional insurance on whatever "package" of loans the mortgage in question was sold inside, fourth by the actual house itself (a real, tangible asset that can be repossessed and resold or rented)

This says nothing about the viability of the business model. Yes, real estate is intrinsicly valuable. Even John Law believed that.

, and fifth by the full faith and credit of the U.S. government

Utterly false

They are generally believed to be fully backed by the government but they are not. They have a limited line of credit to the Treasury. Furthermore, the Fed has been discussing the possibility of terminating this line of credit. Gee, I wonder why. They could not be bailed without completely destroying the dollar. Too big to fail and too big to bail.

[AdamSelene235]

bump