Fannie Mae: Beyond Economical Repair?

As an aircraft maintenance professional, I’ve learned many maintenance specialized terms over the years. Terms like “unserviceable” and “ beyond economical repair”, or B.E.R as it’s commonly referred to in the biz.

The term unserviceable basically means that it doesn’t work, but there’s hope; the defective unit or aircraft can be repaired and returned to service. Beyond economical repair on the other hand, means it doesn’t work, there’s no hope, the defective unit or aircraft will never be returned to service, it could be repaired but it’s not economically feasible. In laymen’s terms B.E.R. means broke real good.

After reading an excellent article by Stockhouse Community member Liverless, titled First card of the house to fall? I decided to take a look at the mother of all mortgage finance companies, Fannie Mae (FNM). Surely after a little looking around I would be able find a fact filled wooden stake to thrust in the heart of the current, “ the world's financial system is doomed sentiment”.

After poring over Fannie Mae’s financials and many articles, I came to the realization that the metaphoric wooden stake would not be found. If any conclusion could be had, it would be that it was time to drape the windows and doors with garlic, or better yet, gold. If Fannie Mae’s latest financials are any indication, the company could well be, beyond economical repair.

Fannie Mae was created in 1938 as a Government Sponsored Enterprise [GSE], at a time when millions of people could not even dream of home ownership due to a lack of available mortgage funds. From those humble beginnings in the 1930s to the present day, Fannie Mae has grown into a behemoth with a mortgage book of $ 2.7 trillion dollars. Surely a company that guarantees $ 2.7 trillion of mortgages, couldn’t be tossed on to scrap heap with the hundreds of other failed lending companies. Or could it?

Fannie’s financials show a company with $40 billion worth of capital. Over the past five years Fannie became infected with mortgages that were given to people with less than ideal credit, and subprime mortgages. I believe the term subprime is so scary now that we have started to use the term Alt-A mortgages. Call them what you want, they’re not good.

When it comes to the subprime contagion, Fannie Mae has $ 415 billion of subprime and Alt-A mortgages. A simple googling of subprime mortgages, returns a veritable plethora of results. Reading multiple articles from sources as diverse as Bloomberg and the Wall Street Journal show that these types of loans have decreased anywhere from 10% to 80% from their original issuance price. A 10% write down would equate to $41.5 billion, or $1.5 billion more than Fannies capital.

The figures $ 40 billion and $2.7 trillion, are also indicative of a company that is in serious need of repair. $ 40 billion is 1.5 % of the $2.7 trillion of mortgages it guarantees. One could deduce that a 1.5% hit in the mortgages they guarantee, would result in an elimination of fannies capital. I’m sure its not that simple for a company the size of Fannie Mae.

Another threat to Fannie Mae’s capital is their exposure to the subprime fiasco through bonds backed by those Alt-A /subprime/junk loans. Fannie has $ 76 billion in these questionable bonds, or almost double their $ 40 billion of capital. If Fannie were an airliner it would definitely be calling for maintenance as it taxied to the gate.

The list of things currently wrong at Fannie Mae is by no means short. On November 9th Fannie released their long awaited 1st, 2nd, and 3rd quarter results. The results show that Fannie’s third quarter loss more than doubled to $1.39 billion. Fannie blamed the huge losses on a $2.24 billion hit in derivative contracts, and a further $ 1.2 billion in mortgage defaults.

The first and second quarters were no better. Net income for the first three quarters was $1.5 billion, 57% lower than the previous years $ 3.5 billion. Losses on securities guaranteed by Fannie, were $1 billion, an increase of $ 857 million over the previous year. Credit related losses, jumped by $ 1.6 billion to $ 2 billion.

On December 4th, Fannie Mae announced it was slashing its dividend by 30% and selling $7 billion in special stocks. The selling of the stocks can only be seen as a desperate attempt to raise much needed capital.

By any measure Fannie Mae is a company in serious trouble. Is Fannie beyond economical repair? Can it fail? I doubt it, it’s too big. Many people richer, and smarter than me will not allow it to happen. There is far too much at stake.

The U.S.government would not allow this behemoth to fail. If Fannie Mae or its brother Freddie Mac were to fail, it would take down the entire U.S mortgage market with it. Lawmakers in the U.S are considering raising the limits on the size of loans that Fannie can buy, with the U.S government/tax payer guaranteeing the paper. I’m not sure how this will fix the problem, but I do know that it would definitely perpetuate the kind of questionable practices, that got us in this mess in the first place.

A government bail out of the GSEs would apply further pressure on an already struggling U.S dollar. Global holders of U.S. dollars may begin to cash in their greenbacks for anything, of more value, be it the euro or a shiny yellow metal. An exit of global investment capital coupled with the issues in the mortgage market, would make The implications of a bail out almost as dire as an insolvent Fannie Mae.

Is Fannie Mae beyond economical repair? I sincerely hope not; if Fannie, or Freddie (FRE) were to fail, it would surely signal the beginning of an even greater depression than was seen in the 1930s. If Fannie, or Freddie are bailed out . . .

Disclosure: none

Comments

[MLS-2.com]

What is it about these GSEs that make us want to use plane analogies?!

I wrote this last month about Freddie Mac on the MLS-2 Blog
( blog.mls-2.com/2007/11.../ )

"FNHMC, the number two residential mortgage lender and sanctioned by the government, reported a huge Q3 loss and said they would need to raise additional operating capital. Speculations on that number ranged upwards of $6 Billion! See this blog post on Seeking Alpha for more on the capital infusion.

Freddie Mac stock plummeted 29% Tuesday, dragging down Fannie Mae also 25%, and causing Countrywide to be the bankruptcy talk of the day (again).

This development is huge. Many expect Fannie Mae to report similar losses & problems. Fannie & Freddie were supposed to be our ticket out of this mess, at least in part or at least temporarily…

Well, not only is the ticket no good, but the plane just caught fire sitting at the gate!"

[FairEconomist]

"Subprime" has two meanings. It technically means loans to people with extremely low credit scores (i.e. subprime *borrowers*), which doesn't include Alt-A loans, interest-only, "liar loans", 100% financing, etc. When you see claims that "subprime" is only a few percent of total loans, this is what they're talking about.

Casually, people usually mean the *loan* is not a prime loan. If you consider that a "prime" *loan* means a loan at a fair rate to a borrower with good credit, able to comfortably make the payments and with a respectable down payment, then "subprime" is a huge category (including Alt-A and much, much more), and almost all recent loans in the bubble areas.

The problem is that all of the second category is at risk in the current housing downturn. Nobody cares what the mortgage industry's technical definition of "subprime" is, we care about what loans may lose money for institutions like Fannie Mae. It would take a miracle to save an institution like Fannie Mae with a 1.5% capital ratio with house prices forecast to fall 10% by the Case-Shiller housing futures index.

[User 131184]

Fannie Mae holds 2.7 Trillion in mortgages that lose 10%...

Big deal, Bernanke prints 270 Million dollars to make up the difference.

Physical money supply has been increasing by 8% per year for a long time, a few years at 10% and most people wouldn't notice or care besides the initial sticker shock of $5 gasoline.

[staceylaliberte]

"Big deal, Bernanke prints 270 Million dollars to make up the difference."


Ummm, I think you mean 270 billion dollars.(it's o.k. who can fathom a trillion anyway?)

This is a huge deal. American dollars are beginning to be viewed as nothing more than I.O.U.'s .

Iran has recently announced that it will no longer accept US dollars as payment for oil. They cite the recent devaluing and uncertainty of the greenback as their reasons why, I'm sure Iran has other reasons, (the ongoing peeing contest with the US).

Russia has jumped into the fray with Gazprom requesting payment for it's oil and gas in rubles.

The U.S. dollar is the standard payment for oil because it's the worlds reserve currency, not vice versa. In other words the dollar is not the worlds reserve currency because it's the standard payment for oil.

I'm afraid that the US dollar is losing it's credibility as a reserve currency. Everyday we are inundated with headlines that show just what is backing the US dollar - debt.

The US economy has been running on credit since 2000. The easy credit made for easy home buying, the easy home buying made for rising house prices. the rising house prices made for big lines of credit, the big lines of credit made for wanton spending.

According to an article in the globe and mail US consumer spending accounts for a whopping 72% of US G.D.P. If all the easy money disappears, look out.

Unfortunately big business's love affair with outsourcing American manufacturing, has done little to back the currency either. What it did accomplish, was it converted solid, oops this turning into an article.

As a good Canadian, I would like to apologize to anyone offended by this diatribe.