Transcript Problems at Freddie Mac and Fannie Mae

Problems at Freddie Mac and
Fannie Mae
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Secondary Mortgage Market
Implicit guarantee
Strategies
Problems
Preemptive Actions
Secondary Mortgage Market
• Banks and other financial institutions
offering mortgage in the primary market sell
mortgage to Freddie Mac and Fannie Mae
• Freddie Mac and Fannie Mae package these
loans
Implicit Guarantee
• The federal government will bail out them
when they experience financial distress
• More importantly, both agencies take credit
from this implicit guarantee – securities are
viewed almost risk free
Pass Through Strategy
• Packaging loans to MBS and sell them to
investors, earn a return 0.19% -- “pass
through” strategy
Mortgage Investment Strategy
• Buy MBS, thus regain interest rate risk
– highly profitable – big spread between MBS
return and debt-funding ratio: 1.04% in 2001
– Very high leverage
• Fannie and Freddie have a combined outstanding
debt that is 39 percent of total outstanding US public
debt
Problems
• Rising interest rate  value of mortgage
goes down
• Decreasing interest rate
– Mortgage borrowers pay their loan or refinance,
receiving less payment for mortgage loans they
keep
– Less money to meet debt payment requirement
Essence of Problem
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Preemptive Actions
• Accounting and disclosure requirements
• Monitoring on both agencies’ interest rate
risk and leverage