A year ago federal officials looked at Fannie Mae and Freddie Mac and declared that all was well. The two government-sponsored enterprises (GSEs) largely held conventional loans, though they were about to acquire subprime mortgages.
"Although their $40 billion-plus planned commitment to subprime over the next several years is small compared to the $1.5 trillion subprime market and well less than 1 percent of their combined book of business, it does represent over half their combined GAAP capital," said Office of Federal Housing Enterprise Oversight, government agency that oversees the two giant companies.
A year later Fannie Mae and Freddie Mac have bulked up their capital requirements, they have minimal subprime exposure and yet rumors on Wall Street caused a near panic last week.
Let's try some numbers. Imagine that 15 percent of the $40 billion in subprime loans default. That's financing worth $6 billion -- a lot of money to you and me but not much to Fannie Mae and Freddie Mac. Why?
First, Fannie Mae and Freddie Mac "have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets," according to OFHEO.
Second, foreclosures do not represent 100% losses -- All the $6 billion would not evaporate. Foreclosures get resold at 30-50% market discount. They are not given away for free (don't we all wish).
In the past few years Fannie Mae and Freddie Mac have had major accounting issues and have stumbled both financially and in terms of institutional leadership. But despite massive problems they functioned without interruption, and they functioned well. If this were not the case we would have anything but the low mortgage rates seen in recent months.
Prudence dictates that Fannie Mae and Freddie Mac require careful scrutiny, both with the mortgages they hold and the securities they create. But to date there has been nothing to justify the Wall Street frenzy seen during the past week.
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