Double Trouble With Fannie And Freddie

Although it is probably a coincidence, I thought it was kind of interesting that Bloomberg today features two reports about Fannie Mae (FNM) and Freddie Mac (FRE) that offer insights from individuals who, arguably, represent key power centers in today’s financial universe.

One of those quoted is Warren Buffett, chairman of Berkshire Hathaway, who is in a small circle of investors — with the more recent entrants being hedge fund managers — who have accumulated Croesus-like wealth during the boom times of the past several decades.

The other person cited is Yu Yongding, an ‘influential’ former advisor to the central bank of China, which is one of a burgeoning group of nations that have been similarly blessed by the fruits of globalization and tight markets for oil and other commodities.

As it happens, Buffett and Yu seem to have something in common. That is, neither has anything encouraging to say in regard to the ongoing woes at America’s two largest mortgage lenders.

“Buffett Says Fannie Mae, Freddie Mac `Game Is Over’”:

Fannie Mae and Freddie Mac, the two largest mortgage finance companies, “don’t have any net worth,” billionaire investor Warren Buffett said.

“The game is over’” as independent companies said Buffett, the 77-year-old chairman of Berkshire Hathaway Inc., in an interview on CNBC today. “They were able to borrow without any of the normal restraints. They had a blank check from the federal government.”

Freddie Mac and Fannie Mae touched 20-year lows yesterday on the New York Stock Exchange on speculation a government bailout will leave the stocks worthless. U.S. Treasury Secretary Henry Paulson won approval from Congress last month to pump emergency capital into the companies, which account for more than half of the $12 trillion U.S. mortgage market.

Fannie and Freddie mispriced their products and “kept existing because they had the federal government behind them,” Buffett said. Berkshire had been among the largest holders of Freddie until about 2001, when it became apparent the company wasn’t being run well, he said.

The two mortgage companies recorded almost $15 billion in combined net losses in the past four quarters as delinquencies rose to record levels, shrinking their capital. The swoon sparked concern they may not be able to weather the worst housing slump since the Great Depression and prompted Paulson to step in with a rescue plan.

Fannie, down 95 percent in the past year, advanced 24 cents $3.40 at 8:18 a.m. in New York trading. The stock was trading at almost $70 a year ago. Freddie advanced 23 cents to $3.39 and is down 91 percent this year.

Market Value

Fannie’s market value has shrunk to $5.2 billion from almost $40 billion at the beginning of the year. Freddie has declined to $2 billion from $22 billion, making it increasingly difficult for the companies to raise new funds.

Fannie Mae was created as part of Franklin D. Roosevelt’s New Deal in the 1930s, a time when the U.S. economy was struggling to emerge from the stock market crash, industrial production had tumbled 50 percent and the unemployment rate rose as high as 30 percent. Freddie started in 1970, when the economy was strained by the Vietnam War.

Both have the implicit guarantee of the U.S. government, so they can borrow at lower rates than banks and make money by purchasing higher-yielding mortgages from home lenders, providing new capital for loans.

Discomfort

Buffett had an 8.5 percent stake in Freddie until he became “uncomfortable” with the risks Freddie was taking on. In 2005, he said “it would not be the end of the world” if Fannie and Freddie stopped buying new mortgages.

Former Federal Reserve Chairman Alan Greenspan and Richmond Federal Reserve Bank President Jeffrey Lacker have called for the companies to be nationalized. William Poole, former head of the St. Louis Fed said last month Freddie is technically insolvent and Fannie’s fair value may be negative next quarter.

“Freddie, Fannie Failure Could Be World ‘Catastrophe,’ Yu Says”:

A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China’s central bank.

“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to questions yesterday. “If it is not the end of the world, it is the end of the current international financial system.”

Freddie and Fannie shares touched 20-year lows yesterday on speculation that a government bailout will leave the stocks worthless. Treasury Secretary Henry Paulson won approval from the U.S. Congress last month to pump unlimited amounts of capital into the companies in an emergency.

China’s $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong. The Chinese government probably holds the bulk of that amount, according to McCormack.

Industrial & Commercial Bank of China yesterday reported a $2.7 billion holding. Bank of China Ltd. may have $20 billion, according to CLSA Ltd., the Hong Kong-based investment banking arm of France’s Credit Agricole SA. CLSA puts the exposure of the six biggest Chinese banks at $30 billion.

‘Beyond Imagination’

“The seriousness of such failures could be beyond the stretch of people’s imagination,” said Yu, a professor at the Institute of World Economics & Politics at the Chinese Academy of Social Sciences in Beijing. He didn’t explain why he held that view.

China’s government hasn’t commented on Fannie and Freddie.

Yu is “influential” among government officials and investors and has discussed economic issues with Premier Wen Jiabao this year, said Shen Minggao, a former Citigroup Inc. economist in Beijing, now an economist at business magazine Caijing.

Investor confidence in Fannie and Freddie has dwindled on speculation that government intervention is inevitable. Washington-based Fannie has fallen 88 percent this year, while Freddie of McLean, Virginia, has slumped 91 percent.

Paulson got the power to make purchases of the two companies’ debt or equity in legislation enacted July 30 that was aimed at shoring up confidence in the businesses. He has said the Treasury doesn’t expect to use that authority.

The two companies combined account for more than half of the $12 trillion U.S. mortgage market.

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