Fannie Mae and Freddie Mac are insolvent


http://www.bloomberg.com/apps/news?pid=20601087&sid=aefOxE9thfw8&refer=home

Fannie, Freddie Tumble on Bailout Concern, UBS Cut (Update3)

By Dawn Kopecki and Shannon D. Harrington

July 10 (Bloomberg) -- Fannie Mae and Freddie Mac, the two biggest providers
of financing for U.S. home loans, fell to the lowest levels in 17 years in
New York trading after a former Federal Reserve president said the companies
may need a government rescue.

Fannie Mae tumbled as much as 24 percent and Freddie Mac slumped as much as
34 percent in New York Stock Exchange composite trading after UBS AG
analysts said in a report today that Freddie Mac's decline creates
``challenges'' for the company's plan to raise $5.5 billion.

Chances are increasing that the U.S. will bail out Fannie Mae and Freddie
Mac because they don't have enough capital to weather the worst housing
slump since the Great Depression, former St. Louis Federal Reserve President
William Poole said in an interview. Freddie Mac owed $5.2 billion more than
its assets were worth in the first quarter, making it insolvent under fair
value accounting rules. The fair value of Fannie Mae assets fell 66 percent
to $12.2 billion, data provided by the Washington- based company show, and
may be negative next quarter, Poole said.

``Congress ought to recognize that these firms are insolvent, that it is
allowing these firms to continue to exist as bastions of privilege, financed
by the taxpayer,'' Poole, 71, who left the Fed in March, said in the
interview yesterday.

Poole roiled markets in 2003 when he said the government should consider
severing its implied backing of Fannie Mae and Freddie Mac and the companies
lack the capital to weather financial market disruptions. In 2006 and 2007
he called for lawmakers to strip Fannie Mae and Freddie Mac of their
charters.

McCain

The companies, created to boost homeownership and promote market stability,
own or guarantee about half the $12 trillion in U.S. home loans outstanding.
In addition to those obligations, Fannie Mae has $831 billion in company
bonds outstanding, while Freddie Mac has $644 billion, according to
Bloomberg data.

Senator John McCain, the presumptive Republican presidential nominee, said
the federal government can't allow them to fail.

Fannie Mae and Freddie Mac ``are vital to Americans' ability to own their
own homes,'' McCain said in response to a reporter's question during a
campaign stop at a diner in Livonia, Michigan. ``They will not fail; we
cannot allow them to fail.''

Fair value accounting measures a company's net worth if it had to liquidate
all of its assets to repay liabilities. Fannie Mae and Freddie Mac, both of
which have the implicit backing of the government, make money by borrowing
in the bond market and reinvesting the proceeds in higher-yielding mortgages
and securities backed by home loans.

Stock Price Target

Fannie Mae slumped $1.97 to $13.34 at 2:56 p.m., extending declines for the
year to 67 percent. Freddie Mac tumbled $2.36 to $7.90, taking its 2008
slide to 77 percent. UBS AG analysts led by Eric Wasserstrom in New York
increased their estimates for losses at Freddie Mac and cut their price
target for the stock to $10 from $28 after meeting with Freddie Mac's chief
financial officer Anthony Piszel and controller David Kellerman, according
to a report today.

Fannie Mae and Freddie Mac have raised a combined $20 billion since December
to cover losses of more than $11 billion generated since the credit crisis
began last year. Freddie Mac has yet to raise a planned $5.5 billion,
scheduled for mid-year.

Paulson, Bernanke

U.S. Treasury Secretary Henry Paulson told lawmakers in Washington today
that he's been assured by the regulator for Fannie Mae and Freddie Mac that
the companies have enough capital.

The Office of Federal Housing Enterprise Oversight ``has made clear that
they are adequately capitalized,'' Paulson said in testimony to the House
Financial Services Committee. Federal Reserve Chairman Ben S. Bernanke also
appeared.

The Treasury has been discussing what to do if Fannie Mae and Freddie Mac
fail for months as part of its contingency planning, the Wall Street Journal
reported today, citing three people familiar with the matter. The government
doesn't expect the companies to fail and it doesn't have a rescue plan in
place, the Journal said.

``At some point we're going to reach that inflection, where the government
is going to have to either guarantee explicitly or Fannie and Freddie are
going to have be left to fend for themselves,'' Peter Boockvar, an equity
strategist at Miller Tabak & Co. in New York, said in an interview with
Bloomberg Television yesterday. ``We're getting to that point where a
decision has to be made by Washington.''

`Well-Capitalized'

The government is counting on Fannie Mae and Freddie Mac, which own or
guarantee about half the $12 trillion in home loans outstanding, to help
revive the housing market. Congress lifted growth restrictions on the
companies, eased their capital requirements and allowed them to buy bigger
``jumbo mortgages'' to spur demand for home loans as competitors fled the
market.

``We are managing our business and maintaining a capital position that will
allow us to fulfill our congressionally chartered mission now and in the
future,'' Brian Faith, a spokesman for Fannie Mae, said.

Poole is ``a long-time critic,'' said Sharon McHale, a spokeswoman for
McLean, Virginia-based Freddie Mac.

``Freddie Mac is doing exactly what Congress intended when it chartered the
company and, more recently, when it passed the Economic Stimulus Act,''
McHale said. ``We are well capitalized and positioned to continue to serve
our vital housing mission.''

Government Ties

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home
buying in the U.S. The companies' charters give the Treasury the authority
to buy as much as $2.25 billion in each of their securities in the event of
possible default.

The government will likely be forced to take over the companies because of
the mortgage meltdown, Poole said.

``We know in a crisis the Federal Reserve tap would be open,'' said Poole,
now a senior fellow at the Cato Institute.

The bailout of Bear Stearns Cos. by JPMorgan Chase & Co., arranged by the
Fed, demonstrates the government's unwillingness to allow ``large,
systemically important'' financial institutions to fail, he said. Bear
Stearns collapsed after customers fled amid speculation the company faced a
cash shortage.

``I worry about those institutions,'' retired Richmond Fed President Alfred
Broaddus said. ``They are huge. They dwarf the Bear Stearns issue. In the
very worst case scenario, I don't know how you do it other than extend money
and the public takes the loss.''

$20 Billion Raised

The companies have access to the Fed's so-called Fedwire payments system
allowing them to access funding if needed, said Vincent Reinhart, the Fed's
chief monetary-policy strategist from 2001 until September 2007.

They can withstand the slump in part because most of their investments are
mortgages made before 2006 when lending standards were tighter, making them
less likely to default, said Eileen Fahey, a Chicago-based analyst at Fitch
Ratings.

``We do not believe they are technically insolvent,'' Fahey said. ``People
seem to lose sight of the fact that a majority of the mortgages that they
are holding and are guaranteeing were originated pre-2006.''

Comments by the companies' regulator this week that they are adequately
capitalized also eased concern, said Lawrence Yun, chief economist of the
National Association of Realtors in Washington. The companies have about $80
billion of regulatory capital supporting $5.2 trillion of mortgages.

``Just given the size of the two companies, surely the government would not
stand aside'' and let them fail, Yun said.

Record Spreads

Fannie Mae sold $3 billion of two-year notes yesterday to yield 74 basis
points more than Treasuries. A basis point is 0.01 percentage point. That's
the widest spread since Fannie Mae first sold two-year notes in 2000 and
triple what it paid in June 2006.

Fannie Mae's spreads relative to two-year interest-rate swap spreads,
considered a gauge of investors' perception of credit risk, remain about 12
basis points below a four-year high that was reached in March, Bloomberg
data show.

Fannie Mae debt was trading 13 basis points tighter than two-year swap
spreads today compared with 2 basis points tighter on March 19, Bloomberg
data show. Freddie Mac spreads are about 19 basis points tighter than swap
spreads after trading at the same level as swaps on March 17. Swap spreads
are the difference between interest-swap rates above Treasury yields.

Credit-Default Swaps

The price of credit-default swaps, contracts used to speculate on the
creditworthiness of Fannie Mae and Freddie Mac, doubled in the past two
months to more than 80 basis points for the senior debt, according to
London-based CMA Datavision.

The median credit-default swap on debt rated Aaa by Moody's was 36 basis
points as of yesterday, data from the rating firm's strategy group show. It
was 87 basis points for debt rated A3.

Credit-default swaps are financial instruments based on bonds and loans that
are used to speculate on a company's ability to repay debt. They pay the
buyer face value in exchange for the underlying securities or the cash
equivalent should a borrower fail to adhere to its debt agreements. A basis
point on a contract protecting $10 million of debt from default for five
years is equivalent to $1,000 a year.

To contact the reporter on this story: Dawn Kopecki in Washington at
dkopecki@xxxxxxxxxxxxx; Shannon D. Harrington in New York at
sharrington6@xxxxxxxxxxxxxx

Last Updated: July 10, 2008 14:59 EDT


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