The Complicated World of Fannie and Freddie
By: Dr. Charles Lieberman
Date: 7/29/2008
Some people claim Fannie and Freddie have depleted their entire capital base. Others claim they are well capitalized. If building (or rebuilding) their capital base were the only objective, the GSEs would halt new lending and investing activities, since monthly mortgage payments reduce each of their mortgage holdings by more than $100 million each month. In fact, politics, economics and accounting rules make a very complicated mix that greatly confuses the issues. It is my judgment that the situation is not dire and both firms will do very well, especially with the support of Paulsons Treasury behind them.
Those who argue that the GSEs have no capital left base their argument purely on "fair value accounting", which assumes that all of the mortgages owned by the GSEs are valued at current depressed market prices in a somewhat dysfunctional market. (Valued under the same rules, most of the banks in the country are also likely bankrupt.) The problem isn't the banks. It's the rules. That's how it is possible for one well known money manager to claim that more than $1 trillion in losses will be reported when there are only about $12 trillion in mortgages outstanding, the default rate is less than 2% and not all is lost in a default when the real estate is repossessed and sold. Thats very disappointing, because $1 trillion does make a nice round number that really makes very good headlines.
The GSEs have plenty of capital, actually more than enough to also meet an 20% excess capital requirement, especially since their default rate is below 1%. Still, their capital base is not adequate because Treasury officials understand that they need the GSEs to keep lending to help the mortgage market recover. With banks reluctant to lend, Treasury needs the GSEs to keep lending, which also requires capital. Paulson understands this point. Others have different motivations. So, the GSEs need more capital to handle any future losses, as well as incremental lending. In this capacity, they are acting in the public's interest, not in their own. And it is for this reason that Paulson and the U.S. Treasury will stand behind them. They will play a key role in fixing the housing market. In time, once they stop reporting accounting losses, their surging profitability will become manifest, must to the enormous frustration of those who wish to see they destroyed. That now appears to be a battle for another day. Download this article in PDF Format
About Advisors Capital Management, LLC
Advisors Capital Management, LLC (ACM) is a provider of managed portfolios and financial services for industry professionals and their clients. As investment strategist, Dr. Lieberman oversees the company's "Portfolio Partners" investment program. Additionally, he provides guidance to the ACM Wealth Coordinators who integrate the work of financial advisors, financial planning, tax, estate and portfolio management professionals to build, protect, and maintain clients' wealth. Although the information included in this report has been obtained from sources Advisors Capital Management, LLC believes to be reliable; we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
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