Wednesday, August 12, 2009

Modelling Fannie Mae and Freddie Mac – Part 1 (FRE; FNM)

Ah Bronte Capital.
You may remember him from "Latvian Hookers Signal No Recovery for Economy" where we linked to:

Hookers that cost too much, flash German cars and insolvent banks: an introduction to Swedbank’s Baltic homeland

Hookers that still cost too much – some comments on the IMF and Latvia

Polish hookers don’t cost too much

The hookers no longer cost too much: geopolitics and the price of prostitutes in the Baltic States

Today he looks at the former GSE's:

This will be the first on a series of posts about Fannie Mae and Freddie Mac. I expect my conclusions to be controversial. One reason I have been quieter than normal on the Bronte Capital blog it is because I am working on this series.

The lack of analysis in the public domain

The discussions about the future of these two institutions (and indeed discussions about the whole shape of the government budget) are taking place in a vacuum – where there are no decent public analyses of the government’s contingent liabilities with the two GSEs. The main part of this series will be to remedy that oversight.

I write this series in the face of genuine press and public surprise at the relatively good results of Freddie Mac. I am not meaning to sound boastful, but I privately predicted those results quite accurately. This series will explain how I got to that prediction – and where Fannie and Freddie losses go from here.*

Where the losses do not come from – losses on traditional Fannie and Freddie business

Fannie and Freddie traditionally insure qualifying mortgages. These are mortgages with:

  • loan to valuation ratios of less than 80 percent (or with supplementary mortgage insurance for higher loan to value ratios)
  • principal amounts owing lower than the qualifying mortgage limit (which used to be below $300 thousand but has been increased several times and sharply during this crisis)
  • with income, employment and assets verified

These mortgages were never very risky – and to date have caused very few problems (although Fannie and Freddie are provisioning for enormous problems that will come).

I can demonstrate this.

At the end of 2007 Freddie Mac had $26.7 billion in common stockholders’ equity and 14.1 billion in preference shares outstanding – a total of $41.1 billion in capital....MORE

Here's part II:

This post is entirely about the losses that Fannie Mae and Freddie Mac have realised to date. It is not about the losses that they will realise in the future. Models of those losses will be provided in Part IV in which I model the traditional guarantee business....MORE