We linked to Bronte Capital's parts one and two in "Modelling Fannie Mae and Freddie Mac – Part 1 (FRE; FNM)" which started off:
Here's Part III:
Ah Bronte Capital.
You may remember him from "Latvian Hookers Signal No Recovery for Economy" where we linked to:
Today he looks at the former GSE's...
In the previous post I showed you what had caused the big losses at Fannie and Freddie to date. In short it was mark-to-market securities (on private label securities and the like) and interest rate hedging instruments that collapsed in value as interest rates went to zero.
I also showed that these losses were not likely to continue to be a drain on Fannie or Freddie.
What matters now is the vast (multi-trillion dollar) books of traditional business that they guarantee – mom and pop mortgages by people with good credit and no fancy mortgage terms or liars loans. These have not caused many actual losses to date (less than $6 billion at each company) but the provisions for losses from this business are large and getting larger.
It’s the future losses we need to worry about. And so now – unlike in the last post – I need to make estimates about the future to see what losses will be. Casey Stengel argued you should “never make predictions, especially about the future”. At the risk of being exposed as a fool I am going to breach Mr Stengel’s advice.
However I have some tools for making these predictions. The purpose of this post is to introduce readers to the tools…
Default curves that point to the sky
Both Fannie and Freddie publish default curves by vintage. Here is the Freddie Mac curve from the last quarterly results…
And here is the Fannie Mae curve from the last quarterly…MORE
He'll be looking at the future problems in part IV.