Former St. Louis President Poole Calls Freddie, Fannie "Insolvent"

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Just a few weeks ago, experts were saying the credit crisis was on the mend and we could all get back in the pool. But as we discussed in an earlier post, worries about Fannie and Freddie are on the rise, and the increase in agency spreads back in January was probably the biggest trigger of the last acute phase of the credit crunch that peaked in March with the bailout of Bear Stearns.

Bloomberg reports that former Fed president Richard Poole said the GSEs are insolvent and that Congress needs to recognize this fact. This is, needless to say, a provocative statement, particularly from a former regulator. The officialdom generally accepts the premise that more than a little dissembling is OK if it keeps the great unwashed public from worrying about things that are deemed to be beyond them.

But Poole didn’t respect that convention even during his term. He has long been a critic of the half pregnant status of the GSEs. In 2003, he rattled markets by saying the government should strip them of their implied backing (some readers point out that Fannie and Freddie securities clearly say that they are not guaranteed by the government but their prices say the world at large thinks otherwise) and in 2006 and 2007 said their charters should be revoked.

From Bloomberg (hat tip Dwight):

Borrowing at Fannie Mae, the government-sponsored mortgage company, has never been so expensive and it may not get better any time soon.

Fannie Mae paid a record yield relative to Treasuries on the sale of $3 billion in two-year notes yesterday amid concern the biggest provider of financing for U.S. home loans won’t have enough capital to weather the worst housing slump since the Great Depression. The company’s credit-default swaps show traders are treating the AAA rated debt as if it were five steps lower. Fannie Mae shares tumbled 13 percent yesterday in New York to the lowest level in almost 14 years.

Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae’s assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.

“Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,” Poole, 71, who left the Fed in March, said in an interview…

“At some point we’re going to reach that inflection, where the government is going to have to either guarantee explicitly or Fannie and Freddie are going to have be left to fend for themselves,” Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York, said in an interview with Bloomberg Television. “We’re getting to that point where a decision has to be made by Washington.”…

The government is counting on Fannie Mae and Freddie Mac, which own or guarantee about half the $12 trillion in home loans outstanding, to help revive the housing market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger “jumbo mortgages” to spur demand for home loans as competitors fled the market.

Paulson said on July 8 he was pleased with Fannie Mae and Freddie Mac’s efforts to raise capital. Bernanke said the same day the firms need to be “strong, well-regulated, well- capitalized” to provide credit “without posing undue risks to the financial system or taxpayer.”….

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies’ charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default.

The government will likely be forced to take over the companies because of the mortgage meltdown, Poole said.

“We know in a crisis the Federal Reserve tap would be open,” said Poole, now a senior fellow at the Cato Institute…

“I worry about those institutions,” retired Richmond Fed President Alfred Broaddus said. “They are huge. They dwarf the Bear Stearns issue. In the very worst case scenario, I don’t know how you do it other than extend money and the public takes the loss.”…

The companies have access to the Fed’s so-called Fedwire payments system allowing them to access funding if needed, said Vincent Reinhart, the Fed’s chief monetary-policy strategist from 2001 until September 2007.

They can withstand the slump in part because most of their investments are mortgages made before 2006 when lending standards were tighter, making them less likely to default, said Eileen Fahey, a Chicago-based analyst at Fitch Ratings.

“We do not believe they are technically insolvent,” Fahey said. “People seem to lose sight of the fact that a majority of the mortgages that they are holding and are guaranteeing were originated pre-2006.”

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  1. Doc Holiday

    Fannie remains guilty of fraud and taxpayers should not be expected to bail out criminals!!!!! These people need to be in prison ASAP!!!! Fra…Franklin_Raines

    In a settlement with OFHEO and the Securities and Exchange Commission, Fannie paid a record $400 million civil fine. Fannie, which is the largest American financier and guarantor of home mortgages, also agreed to make changes in its corporate culture and accounting procedures and ways of managing risk. [9]
    In June 2008 Wall Street Journal reported that Franklin Raines was one of several politicians who got below market rates loans at Countrywide Financial because the corporation considered the officeholders “FOA’s”–“Friends of Angelo” (Countrywide Chief Executive Angelo Mozilo)

  2. Doc Holiday

    This also gets back to the issue of Warsh, et al being pushed into power by de facto appointments, and thus the on-going collusion in The Fed, which damn well needs to stop. Poole is coming clean, because he apparently is trying to be honest here and speaking freely, versus be a part of that team hell-bent on abusing the trust of American taxpayers. This pisses me off to see The Fed out of control and unaccountable! Congress and the highly corrupt and inefficient Senate need to begin investigations in the morning and make damn well sure that Dodd is removed from duty in the process! We can not afford to have Friends Of Angelo members, like Dodd pretending to be part of the subprime solution — it is our entire government and The Bush Coup that IS The Problem! God help us all!

  3. Lune

    With all due respect to Mr. Poole, do you really think a Fed that bailed out Bear Stearns wouldn’t bail out GSEs? The govt can cry “no guarantee” until its face is blue, but especially after the rescue of BSC, the good money is betting on the fact that the GSEs will be bailed out at taxpayer expense.

    Is this moral hazard? Of course. Is it an appalling waste of enormous sums of taxpayer money? Absolutely. Will it establish horrendous precedents by essentially nationalizing the American housing market? You bet. But that would all be par for the course for Bernanke’s Fed so far.

  4. etc

    The Fed will keep bailing out big banks unless it triggers a crisis. An obvious one being the foreign central banks finally getting beat up by foreign populists to stop losing money by investing in USD denominated debt, forcing a major hike in USD interest rates and/or a major fall in the USD.

  5. Francois

    “But that would all be par for the course for Bernanke’s Fed so far.”

    I’m afraid there’s more to it than Bernanke’s Fed.

    It’s all about the cultural pillars of our society as per Washington DC: homeownership (at the detriment of renting) cheap energy, (not anymore I guess) and the dollar King. (His Majesty doesn’t appear in good health now doesn’t he?)

    All these are under enormous strain now. I cannot imagine politicians from both parties thinking seriously that letting Fannie and Freddie fail would be politically feasible. It would be an admission of total failure.

  6. Ginger Yellow

    Talk of getting rid of even the implicit guarantee now is insane. If they let Fannie/Freddie fail, it would make the Depression look like a mild recession. Winding their balance sheets down over the long term (as the Japanese are doing with the Government Housing Loan Corp) probably makes sense, although now is not the time to do it.

    “Will it establish horrendous precedents by essentially nationalizing the American housing market?”

    The mainstream US housing market has been essentially nationalised for decades. The only thing that really makes it a private market is that there is so much non-mainstream lending, especially compared to other countries.

  7. Ginger Yellow

    Also, I’m not familiar with Fannie/Freddie accounting rules (hoping to get a primer from some of my contacts later today). Are they allowed to fair value their liabilities?

  8. Anonymous

    The principal reason the GSE’s will be bailed out as needed is not because of the effect on housing, but because of who holds the 6 trillion in paper which
    underpin the assets.

  9. Scott

    Ginger Yellow–

    In terms of accounting treatment, Fannie and Freddie play by the same rules, nonsensical as some of them may appear, as everybody else. So yes, they might well opt to show gains based on the falling value of their debt, a la several of the investment banks.


  10. Stuart

    ““We do not believe they are technically insolvent,” Fahey said. “People seem to lose sight of the fact that a majority of the mortgages that they are holding and are guaranteeing were originated pre-2006.””

    Is Fahey completely stupid or ingenuious or both. when a mere 1% drop in asset values would wipe out their entire capital base forcing insolvency or bailout, Fahey saying that most mortgages were pre-2006 is instantly irrelevant. Jesus, these folks..

  11. Anonymous

    “With all due respect to Mr. Poole, do you really think a Fed that bailed out Bear Stearns wouldn’t bail out GSEs? The govt can cry “no guarantee” until its face is blue, but especially after the rescue of BSC, the good money is betting on the fact that the GSEs will be bailed out at taxpayer expense.”

    I think most here agree with you.

    But think of the consequences of that. The dollar would get murdered.

  12. Anonymous

    Is the Fed sure of the amount of ammo it has remaining? If so, I sure hope that’s been clearly communicated to Treasury, FDIC, OFHEO and the other pertinent parties. It seems to me they all gotta make sure they know(as a group), what they have in reserve, then prioritize the importance of each of the struggling entities that are appearing on the radar screen (into a master list) and finally understand how it should be allocated. I.E. Plan specifically how much of the remaining capital is available to support each problem entity. It seems that would be the only knowledgeable way to see which entities (or portions of entities) have to be sacrificed.

    I further believe that if they’re not doing this and instead are relying on rhetoric to talk the markets through the problem- they’re gambling everything. That’s no better many of the frauds (such as Worldcom) that have been committed by companies against investors.

  13. mittelwerk

    the mortgage market is undergoing total covert nationalization … but are you morons still going to keep bitching about the “free market”?

    bah! bah!

  14. awake

    Capitalism weeps today. Everytime the financials are poised for a major market crashing breakdown the Plunge Protection Team ™ or Paulson, Bernanke, & Co. Steps in. Everyone loves the invisible hand of Adam Smith until he gives them the finger. It’s gonna happen eventually.

  15. Anonymous

    What do you expect awake, our nation aren’t exactly full of sharp pencils. And fewer still have any idea what this means.

  16. Anonymous

    Keep in mind:…e- dividend.aspx

    Bank of America’s dividend is currently $2.56 per share, for an 8.6% yield. The 2008 consensus analyst estimate for the bank’s earnings is $2.66 per share. That means that to keep the dividend, the bank will have to pay out virtually everything it earns. Put another way, that’s nearly a 100% dividend payout ratio, compared with the bank’s historical payout ratio of 40% to 50%.

  17. Anonymous

    Fannie and Freddie are completely insolvent and will have to bailed out. The implicit gaurantee, whatever that means, is now going to be explicit! Their charters should have been pulled years ago, before the housing bubble got completely out of control. It is only fitting that the agencies put in place to spur the housing market will now completely unravel what will be the biggest housing crash in US history.

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