Semi-Daily Journal

Hopefully, more people will start examining these two GSEs (Fannie & Freddie) more closely now. I've long averred that both are ticking time bombs, even though I've had to face some tough situations because of this [grin]

I think your comment downplays it a bit. The CEO, COO, and CFO were all shown the door in one way or another, so this is a huge shakeup.

Hey, snarking that it's (sarcasm)unexpected(/sarcasm) after-the-fact only gets you half credit. Who's next?

Warren Buffett owned a huge block of FreddiMac shares for many years, then sold a perhaps 2 years ago. I have always been puzzled about why he sold. Derivate use has been worrying Buffett, but I do not quite know why. What does this amount to?

This is plenty odd. Pres/COO is terminated by the board for lack of candor and cooperation with a change of auditors and a restatement effort. No fraud alleged (yet), no direct bearing on restatement alleged (yet), but reports of altering a personal diary.

EVP/CFO and Chmn/CEO resign, with no allegations agaisnt them.

The restatements entail increases in previously stated earnings -- at worst, cookie jar accounting -- and projected future increases in earnings volatility, resulting from differences in treatment of earnings from derivatives.

Derivatives would normally be employed to hedge agaisnt external shocks, i.e., to reduce volatility.

The apparently unforced but unavoidable departure of two senior executives suggests a case of "philosophical differences" (which may easily arise in the PoMo context of accounting and/or strategic use of deriviatives).

Surmise: COO balked on principle over policy disputes, was dismissed on minor pretext, CFO and CEO balked at treatment of COO and resigned on principle.

It's a high-stakes cut-throat game, where many powerful atmospheric forces have philosophical differences with the very existence of the enterprise.

Anne writes:
>Warren Buffett owned a huge block of FreddiMac shares
>for many years, then sold a perhaps 2 years ago. I have
>always been puzzled about why he sold. Derivate use has
>been worrying Buffett, but I do not quite know why. What
>does this amount to?

Looking at the chart, what it amounts to is that Warren Buffet knows how to buy low and sell high. :-) The stock has done nothing recently (in a positive way). More seriously, I know Buffett doesn't like the use of derivatives, but Buffett doesn't like a lot of things for reasons that are not necessarily very sensible. So I've always wondered about his distaste for stock splits. I think the most Buffet-esque reason why he would not like the use of derivatives by an outfit like Fannie Mae is that they could make the company into an Enron-like "black box". As I understand it, though, Freddie Mac is accused not of inflating earnings, like Enron, but of "managing" them so that they will appear smoother than they really are.

On a probably not completely unrelated topic, treasury yields have gone way down again today. 10 basis points on the five-year index and 8 basis point on the ten-year. I hope all of this liquidity starts doing us some real good right now...

Brad DeLong just made this comment:

"More interesting, I think, is a surprisingly large narrowing in risk and default-driven interest rate spreads that has been ongoing for a while..."

Is the Fed simply assuring enough liquidity that there is almost complete protection for high credit risk companies? There is lots of moeny to be borrowed, and interest rates spreads between high and low credit risk companies has rapidly nharrowed. Merrill Lynch seems to think so.

But how much risk is there for an entity like Fannie Mae or Freddie Mac?

Are they purchasing the most risky mortgages from primary lenders, or the least risky, or are they purchasing a representative portfolio of mortgage loans?

I'd always assumed they were taking the least risky loans, thus making financing available for banks to extend loans to progressively "more risky" customers, but without taking on too much risk themselves.

The purpose of these entities isn't to take on risk, it's to promote liquidity that will encourage banks to take on risk, isn't it?

It would be interesting if someone would compare/contrast this with the Japanese banking situation...

FreddieMac and FannieMae are fierce in defending their franchises. An analyst who questions company practice or projections is liable to be dealt with harshly by the companies. My guess is that the problem at FreddieMac is more than a trifle.

Not that I don't think these agencies aren't a catastrophe in the making, but isn't the reason why these guys are being shown the door is because they were trying to squirrel money under the carpet ? That is, they weren't trying to hide losses, they were trying to hide profits. Mind you, I can't recall where I got that from, so I might be totally clueless.

Anne: "Is the Fed simply assuring enough liquidity that there is almost complete protection for high credit risk companies?"

I don't think that's fair. Individual credits still receive a risk spread that tries to categorize their riskiness appropriately. The Fed isn't in the business of picking winners and losers; in helping the economy, it is no doubt helping some troubled and/or mismanaged companies. Also, if you look at the high-yield market, you will see that the weaker credits are much, much stronger than they were 6 months ago; but I wouldn't say that these companies are granted "complete protection."

About Freddie Mac, the charges that brought down the management team seem too minor to have done so. It's the perfect situation in which to wonder if something more is going on.

Not that I don't think these agencies aren't a catastrophe in the making, but isn't the reason why these guys are being shown the door is because they were trying to squirrel money under the carpet ? That is, they weren't trying to hide losses, they were trying to hide profits. Mind you, I can't recall where I got that from, so I might be totally clueless.

Not that I don't think these agencies aren't a catastrophe in the making, but isn't the reason why these guys are being shown the door is because they were trying to squirrel money under the carpet ? That is, they weren't trying to hide losses, they were trying to hide profits. Mind you, I can't recall where I got that from, so I might be totally clueless.

We should consider the possibility that, unlike most privately financed entities, the mortgage agencies have a shadow "board", the US Congress, in addition to their real board of directors, and that is what has made the difference in this situation. Congressman Baker of Louisiana has (with the help of the Wall Street Journal's editorial page) run a crusade against Freddie and Fannie. When something irregular comes along, seeing bodies fly out the door doesn't seem all that odd in such a circumstance, even if the "something odd" is not really all that threatening. The issue for the big mortgage agencies is whether they represent systemic risk an a big way. There are plenty of worries (including fromg Greenspan), but so far no evidence. It is still early, but there has been no problem trading Agency debt, the widening in their credit spreads has been modest, despite a good bit of selling, and there is no sign that anybody (including Freddie) has been threatened with collapse because of this week's troubles.

Any chance the buzz on the timebomb nature of the big mortgage lenders is just wrong?

JT

The Fed is surely not trying to bolster particular companies, but declining rates of interest and rising stock prices have made for lots of affordable loans to low rated companies.

Reading Warren Buffett, the risk in derivatives may be that we do not understand the risks. Also, derivatives are held in concentrated amounts by a fairly few lenders. Alan Greenspan has mentioned, however, there is no problem.

Derivatives may not entirely defy common understanding, but they perfectly well defy common accounting. Just look at the controversies -- some genuine, some specious -- over (relatively simple) employee stock options.

And yet some derivatives are legitimate instruments of prudent management. That's a problem ... and one that can lead to legitimate, intense "philosophical differences".

IIRC, net foreign purchases of US agencies are at record highs... i wonder if foreigners are spooked yet?

http://www.federalreserve.gov/BoardDocs/Speeches/2003/20030307/default.htm

IIRC, net foreign purchases of US agencies are at record highs... i wonder if foreigners are spooked yet?

http://www.federalreserve.gov/BoardDocs/Speeches/2003/20030307/default.htm

IIRC, net foreign purchases of US agencies are at record highs... i wonder if foreigners are spooked yet?

http://www.federalreserve.gov/BoardDocs/Speeches/2003/20030307/default.htm

IIRC, net foreign purchases of US agencies are at record highs... i wonder if foreigners are spooked yet?

http://www.federalreserve.gov/BoardDocs/Speeches/2003/20030307/default.htm

arghh! sorry i kept trying :(

Used to work for Freddie Mac. All the top officers ar Mormons. Very strange company, corporate culture wise. (Eat their young, not mormon, not going anywhere, that kind of thing.)

Used to work for Freddie Mac. All the top officers are Mormons. Very strange company, corporate culture wise. (Eat their young, not mormon, not going anywhere, that kind of thing.)

I used to work at Freddie for a few years and left (thankfully) once I got my green card.

These recent events did not surprise me -- the real story is how such characters lasted for so long. What was the Board doing for so long?

For the long-term I still stick to my prognosis of these two GSEs as ticking time bombs -- they're both catastrophes waiting to happen.

Have a few more posts on my blog

Kenny (Kenny, Kenny, Kenny),

Good point. Foreign accounts hold scads of GSE paper. So far, however, they don't seem in a panic to shed the stuff. Our tracker of coporate investment flows suggests that foreigners have been hit with so much bad news from US markets in recent years (stock market plunge, credit downgrades, corporate hanky-panky) that those who have remained have grown pretty thick skinned. Some recent purchases are probably also partly based on fx strategies - the lower the dollar goes, the closer it is to rebounding - which have not yet paid off. Selling Freddies would require either abandoning the dollar play or picking another (presumably lower yielding) asset.