Thursday, July 24, 2008

Fannie Mae and Freddie Mac ties to Food and Gas Prices

Tomorrow, Friday July 25 2008, the Senate will probably pass the resolution to bail out Fannie Mae and Freddie Mac. Next spring, gasoline will probably be $6 per gallon. When that happens, don't blame the oil companies.

July 26 update

Basically, what this means is that, instead of allowing the people who made unwise mortgage decisions (on both sides) to go bankrupt (which is, after all, what bankruptcy laws are for), we the people will be forced to pay for their indiscretion through higher prices at the gas pump and the grocery store. Just as we have already been doing, as a result of the Federal Reserve Board artificially holding down interest rates to disguise inflation and aid those who have made unwise credit decisions, to the detriment of those who have been wise and invested their money. And ultimately of course, to all our detriment in food and gas prices. They know they can just point the finger at oil execs and other free market businessmen and investors, and the unthinking masses will swallow the bait as always.
Remember this, when gas and groceries go up yet again.

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Freddie Mac

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Federal Home Loan Mortgage Corporation (Freddie Mac)
Type Public
Founded 1970
Headquarters McLean, Virginia
Key people Richard F. Syron, Chairman & Chief Executive Officer; Patti Cook, Chief Business Officer; Anthony Piszel, Chief Financial Officer; Mike Perlman, Operations and Technology; Robert Bostrom, General Counsel and Secretary
Industry Credit services
Products Financial services
Revenue $44.00 billion (2006)
Employees 5,000
Website www.freddiemac.com

The Federal Home Loan Mortgage Corporation (FHLMC) (NYSE: FRE), commonly known as Freddie Mac, is a government sponsored enterprise (GSE) of the United States federal government. It is a stockholder-owned corporation authorized to make loans and loan guarantees. The FHLMC was created in 1970 to expand the secondary market for mortgages in the US. Along with other GSEs, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as mortgage-backed securities to investors on the open market. This secondary mortgage market increases the supply of money available for mortgages lending and increases the money available for new home purchases. The name "Freddie Mac" is a creative acronym of the company's full name that has been adopted officially for ease of identification (see "GSEs" below for other examples).

Contents

[hide]

[edit] History

From 1938 to 1968, the secondary mortgage market in the United States was monopolized by the Federal National Mortgage Association (Fannie Mae), which was a government agency during that period. In 1968, to help balance the federal budget, part of Fannie Mae was converted to a private corporation. To provide competition in the secondary mortgage market, and to end Fannie Mae's monopoly, Congress chartered Freddie Mac as a private corporation.

[edit] Business

Freddie Mac's primary method of making money is by charging a guarantee fee on loans that it has purchased and securitized into mortgage-backed security bonds. Investors, or purchasers of Freddie Mac MBS, are willing to let Freddie Mac keep this fee in exchange for assuming the credit risk, that is, Freddie Mac's guarantee that the principal and interest on the underlying loan will be paid back regardless of whether the borrower actually repays.

Both Alan Greenspan and Ben Bernanke have spoken publicly in favor of greater regulation of the GSEs, because of the size of their holdings and the widespread perception that they are government backed. Freddie Mac is currently regulated by the U.S. Department of Housing and Urban Development (HUD) and its Office of Federal Housing Enterprise Oversight (OFHEO). The United States House of Representatives passed HR 1427 (Federal Housing Finance Reform Act of 2007) to consolidate oversight for Freddie, Fannie, and the Federal Home Loan Banks into a single regulator.[1] [2]

[edit] Conforming loans

The GSEs are allowed to buy only conforming loans, which limits secondary market competition for non-conforming loans. The law of supply and demand accordingly renders the non-conforming loan harder to sell (fewer competing buyers); thus it would cost the consumer more (typically 1/4 to 1/2 of a percentage point, and sometimes more, depending on credit market conditions). OFHEO annually sets the limit of the size of a conforming loan in response to the October to October change in mean home price. Above that conforming loan limit, a mortgage is considered a non-conforming jumbo loan. The conforming loan limit is 50 percent higher in such high-cost areas as Alaska, Hawaii, Guam and the US Virgin Islands, and is also higher for 2-4 unit properties on a graduating scale.

[edit] Guarantees and subsidies

In mid July 2008 there was widespread speculation that the US government would move to provide Freddie Mac with additional guarantees of capital, because of widespread instability in the financial markets and public perceptions of looming insolvency. On Sunday July 13 The Secretary of the Treasury announced that the US government would buy some of Freddie Mac's stock and extend to it the full lending power of the Federal Reserve bank of NY[citation needed](see also press release of the Fed[3]). Private banks currently have access to this resource. Nonetheless, many are calling this move tantamount to a bailout.[citation needed]

[edit] No actual guarantees

The FHLMC states, "securities, including any interest..., are not guaranteed by, and are not debts or obligations of, the United States or any agency or instrumentality of the United States other than Freddie Mac."[4] The FHLMC and FHLMC securities are not funded or protected by the US Government. FHLMC securities carry no government guarantee of being repaid. This is explicitly stated in the law that authorizes GSEs, on the securities themselves, and in public communications issued by the FHLMC.

[edit] Assumed guarantees

There is a wide belief that FHLMC securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies." [5] The Economist has referred to "[t]he implicit government guarantee"[6] of FHLMC and FNMA.

[edit] Federal subsidies

The FHLMC receives no direct federal government aid. However, the corporation and the securities it issues are thought to benefit from government subsidies. The Congressional Budget Office writes, "There have been no federal appropriations for cash payments or guarantee subsidies. But in the place of federal funds the government provides considerable unpriced benefits to the enterprises... Government-sponsored enterprises are costly to the government and taxpayers... the benefit is currently worth $6.5 billion annually." [7]

[edit] Subprime adjustable rate loans

Freddie Mac announced on February 27, 2007 that it will buy a subprime adjustable rate mortgage only if the borrower qualifies for the maximum rate of the loan, rather than merely a low introductory (so-called teaser) rate.

[edit] Company

[edit] Awards

Freddie Mac was named one of the 100 Best Companies for Working Mothers in 2004 by Working Mothers magazine.

Freddie Mac was ranked number 50 in Fortune 500's 2007 rankings.

Freddie Mac was ranked 20 in Forbes' Global 2,000 public companies rankings for 2008.

[edit] Credit rating

See [3]

[edit] Investigations

In 2003, the company revealed that it had understated earnings by almost $5 billion, one of the largest corporate restatements in U.S. history. As a result, in November, it was fined $125 million--an amount called "peanuts" by Forbes. [4]

A 200-page report issued by Office of Federal Housing Enterprise Oversight indicated that the company's records were manipulated to meet Wall Street earnings expectations. The firm signed a consent order promising to improve internal controls and corporate governance. [5]

On April 18, 2006 home loan giant Freddie Mac was fined $3.8 million, by far the largest amount ever assessed by the Federal Election Commission, as a result of illegal campaign contributions. Much of the illegal fund raising benefited members of the House Financial Services Committee, a panel whose decisions can affect Freddie Mac. Notably, Freddie Mac held more than 40 fundraisers for House Financial Services Chairman Michael Oxley, R-Ohio.[6]

[edit] Government Subsidies and Bailout

Officially, Freddie Mac is not given any backing, insurance, or statutory support by the US Government. Unofficially, it has long been assumed that the corporation, along with its sister GSE, the Federal National Mortgage Association (Fannie Mae), were "too big to fail". Both companies often benefited from an implied guarantee of fitness equivalent to truly federally-backed financial groups.

As of 2008, the Federal National Mortgage Association and Freddie Mac owned or guaranteed about half of the U.S.'s $12 trillion mortgage market.[8] This made both corporations highly susceptible to the subprime mortgage crisis of that year. Ultimately, in July of that year, the speculation was made reality, when the US government took action to prevent the collapse of both corporations. The Treasury Department and the Federal Reserve took several steps to bolster confidence in the corporations, including extending credit limits, granting both corporations access to Federal Reserve low-interest loans (at similar rates as commercial banks), and potentially allowing the Treasury Department to own stock.[9] This event also renewed calls for stronger regulation of GSEs by the government.

[edit] References

  1. ^ Greenspan, Alan (2004-02-24). "Testimony of Chairman Alan Greenspan". Federal Reserve.
  2. ^ Associated Press (2007-03-06). "Bernanke seeks stronger mortgage regulation". MSNBC.
  3. ^ [1] Press release of the Fed.
  4. ^ Freddie Mac Debt Securities: Freddie Notes FAQ
  5. ^ Vernon L. Smith, "The Clinton Housing Bubble", Wall Street Journal, December 18, 2007, pA20
  6. ^ The Economist, "Fannie and Freddie ride again", July 5, 2007
  7. ^ Congressional Budget Office, Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac, May 1996
  8. ^ Duhigg, Charles, "Loan-Agency Woes Swell From a Trickle to a Torrent", The New York Times, Friday, July 11, 2008
  9. ^ Luhby, Tami, [2], CNN Money, Monday, July 14, 2008

[edit] See also

[edit] GSEs

[edit] Further reading

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Fannie Mae

From Wikipedia, the free encyclopedia

Jump to: navigation, search

For the Chicago-based chocolate confectionery, see Fannie May.
Federal National Mortgage Association (Fannie Mae)
Type Public
Founded 1938
Headquarters Washington, DC, USA
Key people Daniel H. Mudd, President and CEO
Revenue $44.8 Billion for 2007[1]
Operating income -$5.1 Billion for 2007[1]
Net income -$2.0 Billion for 2007[1]
Total assets $882.5 Billion for 2007[1]
Total equity $44.0 Billion for 2007[1]

The Federal National Mortgage Association (FNMA) (NYSE: FNM), commonly known as Fannie Mae, is a government sponsored enterprise (GSE) of the United States. It is a stockholder-owned corporation authorized to make loans and loan guarantees.

It is the leading market-maker in the U.S. secondary mortgage market, which helps to replenish the supply money for mortgages and enables money to be available for housing purchases. As of 2008, Fannie Mae and the Federal Home Loan Mortgage Corporation (Freddie Mac) own or guarantee about half of the U.S.'s $12 trillion mortgage market. As a result, the corporations were affected particularly hard by the economic downturn in late 2007 and early 2008.

The name "Fannie Mae" is a creative pronunciation of the company's name that has been adopted officially for ease of identification. It is more than an informal nickname; FNMA refers to itself by this name.

Contents

[hide]

[edit] History

Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt's New Deal to provide liquidity to the mortgage market. For the next 30 years, Fannie Mae held a virtual monopoly on the secondary mortgage market in the United States.

In 1968, to remove the activity of Fannie Mae from the annual balance sheet of the federal budget, it was converted into a private corporation.[2] Fannie Mae ceased to be the guarantor of government-issued mortgages, and that responsibility was transferred to the new Government National Mortgage Association (Ginnie Mae).

[edit] The mortgage crisis from late 2007

During the subprime mortgage crisis of late 2007 and 2008 Fannie Mae and Freddie Mac were strongly affected as a result of the immense share of the mortgage market the two corporations own or guarantee. In July of 2008 the government took action to prevent the collapse of both corporations, with echoing the commonly held belief that "Fannie Mae and Freddie Mac play a central role in the US housing finance system" and therefore could not be allowed to fail. The Treasury Department and the Federal Reserve took several steps to bolster confidence in the corporations, including extending credit limits, granting both corporations access to Federal Reserve low-interest loans (at similar rates as commercial banks), and removing the prohibition on the Treasury Department to own stock. Despite these efforts, as of August 2008 both Fannie Mae and Freddie Mac stock have tumbled more than 85% from their one-year prior levels.

[edit] Business

FNMA's primary method for making money is by charging a guarantee fee on loans that it has securitized into mortgage-backed security bonds. Investors, or purchasers of Fannie Mae MBSs, are willing to let Fannie Mae keep this fee in exchange for assuming the credit risk, that is, Fannie Mae's guarantee that the principal and interest on the underlying loan will be paid even if the borrower defaults.

Alan Greenspan and Ben Bernanke have spoken publicly in favor of greater regulation of the GSEs, due to the size of their holdings and the public belief in a government guarantee that does not exist.

[edit] Conforming loans

Fannie Mae (along with Freddie Mac) annually sets the limit of the size of a conforming loan based on the October to October changes in mean home price, above which a mortgage is considered a non-conforming jumbo loan. The GSEs only buy loans that are conforming, to repackage into the secondary market, lowering the demand for non-conforming loans. By virtue of the law of supply and demand, then, it is harder for lenders to sell the loans, thus it would cost more to the consumers (typically 1/4 to 1/2 of a percent.) The conforming loan limit is 50 percent higher in Alaska, Hawaii, .

[edit] Guarantees and subsidies

Speculation that the U.S. government would bail out an insolvent Fannie Mae is a hypothesis that had never been tested until recently, when the subprime mortgage crisis hit the U.S.

On July 11, 2008, the New York Times reported that U.S. government officials were considering a plan for the U.S. government to take over Fannie Mae and/or Freddie Mac should their financial situations worsen due to the U.S. housing crisis[3]. The government officials also stated that the government had also considered calling for explicit government guarantee through legislation of $5 trillion on debt owned or guaranteed by the two companies.

Shares in U.S. mortgage finance firms Fannie Mae and Freddie Mac plunged on Friday, July 11, 2008, and market speculation mounted that the government was set to take them over to resolve their funding problems.

Shares continued to plummet[4] as investors became unsure about the adequacy of the capital held by FNMA. U.S. Treasury Secretary Henry M. Paulson as well as the White House went on the air to defend the financial soundness of Fannie Mae.

Fannie Mae and smaller Freddie Mac own or guarantee almost half of all home loans in the United States. They face billions of dollars in potential losses, and may need to raise additional, potentially substantial, amounts of new capital as the current downturn in the U.S. housing market continues.

Markets assume that the taxpayer will if necessary take on the burden of all their mortgages because they underpin the whole U.S. mortgage market. If they were to collapse, mortgages would be harder to obtain and much more expensive. U.S. Treasury Secretary Henry Paulson has said the government's primary focus is in supporting Fannie Mae and Freddie Mac in their current form.[5]

[edit] No actual guarantees

Fannie Mae receives no direct government funding or backing; Fannie Mae securities carry no government guarantee of being repaid. This is explicitly stated in the law that authorizes GSEs, on the securities themselves, and in many public communications issued by Fannie Mae.

Neither the certificates nor payments of principal and interest on the certificates are guaranteed by the United States government. The certificates do not constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae.

[edit] Assumed guarantees

There is a wide belief that FNMA securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies."[6] The Economist has referred to "[t]he implicit government guarantee"[7] of FHLMC and FNMA. In testimony before the House and Senate Banking Committee in 2004, Alan Greenspan expressed the belief that Fannie Mae's (weak) financial position was the result of markets believing that the U.S. Government would never allow Fannie Mae (or Freddie Mac) to fail.[citation needed]

[edit] Federal subsidies

The FNMA receives no direct federal government aid. However, the corporation and the securities it issues are widely believed to be implicitly backed by the U.S. government. The Congressional Budget Office writes "there have been no federal appropriations for cash payments or guarantee subsidies. But in the place of federal funds the government provides considerable unpriced benefits to the enterprises... Government-sponsored enterprises are costly to the government and taxpayers... the benefit is currently worth $6.5 billion annually."[8]. Fannie Mae and Freddie Mac are required to hold less capital than normal financial institutions: e.g., it is allowed to sell mortgage-backed securities with only half as much capital backing them up as would be required of other financial institutions. Specifically, regulations exist through the FDIC Bank Holding Company Act that govern the solvency of financial institutions. The regulations require normal financial institutions to maintain a capital/asset ratio greater than or equal to 3%.[9] The GSEs, Fannie Mae and Freddie Mac, are exempt from this capital/asset ratio requirement and can, and often do, maintain a capital/asset ratio less than 3%. The additional leverage allows for greater returns in good times, but put the companies at greater risk in bad times, such as during the current subprime mortgage crisis. FNMA is also exempt from state and local taxes. In addition, FNMA and FHLMC are exempt from SEC filing requirements; however, both GSEs voluntarily file their SEC 10-K and 10-Q.

[edit] Financials

FNMA is a financial corporation which uses derivatives to "hedge" its cash flow. Derivative products it uses include interest rate swaps and options to enter interest rate swaps ("pay-fixed swaps", "receive-fixed swaps", "basis swaps", "interest rate caps and swaptions", "forward starting swaps").

Duration gap is a financial and accounting term for the difference between the duration of assets and liabilities, and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate

"The company said that in April its average duration gap widened to plus 3 months in April from zero in March." "The Washington-based company aims to keep its duration gap between minus 6 months to plus 6 months. From September 2003 to March, the gap has run between plus to minus one month."

In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report [2] on September 20, 2004, alleging widespread accounting errors, including shifting of losses so senior executives could earn bonuses.

Fannie Mae was expected to spend more than $1 billion in 2006 alone to complete its internal audit and bring it closer to compliance. The necessary restatement was expected to cost $10.8 billion, but was completed at a total cost of $6.3 billion in restated earnings as listed in Fannie Mae's Annual Report on Form 10-K.

Concerns with business and accounting practices at Fannie Mae predate the scandal itself. On June 15, 2000, the House Banking Subcommittee On Capital Markets, Securities And Government Sponsored Enterprises held hearings on Fannie Mae[3].

On December 18, 2006, U.S. regulators filed 101 civil charges against chief executive Franklin Raines; chief financial officer J. Timothy Howard; and the former controller Leanne G. Spencer. The three are accused of manipulating Fannie Mae earnings to maximize their bonuses. The lawsuit sought to recoup more than $115 million in bonus payments, collectively accrued by the trio from 1998–2004, and about $100 million in penalties for their involvement in the accounting scandal.

[edit] Further reading

[edit] References

  1. ^ a b c d e "Google Finance: Fannie Mae". Google. Retrieved on 2008-08-06.
  2. ^ Krishna Guha, Saskia Scholtes, James Politi: Saviours of the suburbs, Financial Times, June 4, 2008, page 13
  3. ^ Duhigg, Charles, "Loan-Agency Woes Swell From a Trickle to a Torrent", The New York Times, Friday, July 11, 2008
  4. ^ Michael M. Grynbaum: Woes at Loan Agencies and Oil-Price Spike Roil Markets, New York Times, July 12, 2008
  5. ^ Paulson stands by Fannie and Freddie [1]
  6. ^ Vernon L. Smith, "The Clinton Housing Bubble", Wall Street Journal, December 18, 2007, p. A20
  7. ^ The Economist, "Fannie and Freddie ride again", July 5, 2007
  8. ^ Congressional Budget Office, Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac, May 1996
  9. ^ FDIC: FDIC Law, Regulations, Related Acts - Bank Holding Company Act

[edit] See also

[edit] External links

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