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Fannie Mae may face $24bn derivatives losses
Financial Times ^ | March 9 2004 | Stephen Schurr

Posted on 03/09/2004 5:24:38 PM PST by M. Dodge Thomas

Fannie Mae paid a net $25.1 billion on derivatives transactions in under four years - nearly all of which may represent losses that cannot be recouped, in turn depressing future earnings.

The potential scale of the liabilities, which have yet to be recognised in the company's earnings or in the minimum capital adequacy required by its regulator, raise fresh doubts about the financial health of the mortgage finance giant.

Regulation of Fannie Mae and its sibling Freddie Mac is rapidly moving up the agenda in Washington, amid concerns that the two goverment-sponsored entities have grown so big that they pose a systemic risk to the US financial system. The two entities own or guarantee mortgages totalling $4,000bn.

On Tuesday John Snow, US Treasury secretary, renewed the criticism, saying: "We don't believe in a too-big-to-fail doctrine, but the reality is that the market treats the paper as if the government is backing it."


TOPICS: Business/Economy; News/Current Events
KEYWORDS: derivatives; fanniemae
Also See:

Fannie Mae says that AOCI (Accumulated Other Comprehensive Income ) is irrelevant to current earnings or capital levels, saying it provides a misleading view of the company's fiscal health. Jonathan Boyles, Fannie Mae's vice-president for financial standards and taxes, argues that "every financial regulator always ignores the AOCI amount".

But Fannie Mae's critics say it does matter. Cliff Stearns, a Republican congressman, said in House testimony last year that Fannie complies with Financial Accounting Standards (FAS) 133, which governs derivatives accounting. But Mr Stearns says that in correctly applying this rule, Fannie Mae has "used the special hedge accounting rule to defer the billions of dollars in lost shareholder value to the future"...

http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1078381640936&p=1012571727088

- or -

http://tinyurl.com/3bl96

And:

Because Fannie Mae does not disclose the amount, it is impossible to determine the precise total. However, the company's reports offer several methods to assist efforts to determine a reasonable estimate.

The total cash flow hedge losses in AOCI are the sum of the realized and unrealized derivative gains and losses. Therefore, one can arrive at the realised losses by subtracting the unrealised amount from the total. Fannie Mae does not disclose the unrealised figure. However, the vast majority of its $1,072bn derivatives portfolio gets classified as cash flow hedges.

Fannie Mae breaks down the notional value of its various derivatives positions. The Financial Times concluded the best method of estimating the amount of realised cash flow hedge losses is to apportion gains and losses by notional value.

When net values are broken down by proportion in this manner, the unrealised cash flow hedge losses would total $1.1bn.

At the end of the third quarter, Fannie Mae's AOCI was negative $24.757bn on a pretax basis (on an after-tax basis, the total was $16.092bn). If AOCI is the sum of realised and unrealised derivatives positions, then subtracting the $1.1bn would mean Fannie Mae's total realised derivatives losses would be $23.653bn (or, on an after-tax basis, $15.375bn).

http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1078381650569&p=1012571727088

- or -

http://tinyurl.com/2j3py

1 posted on 03/09/2004 5:24:40 PM PST by M. Dodge Thomas
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To: M. Dodge Thomas
I'm afraid I don't understand how it could lose money at all. Massive defaults on home loans are not occurring.
2 posted on 03/09/2004 5:30:15 PM PST by Dog Gone
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To: M. Dodge Thomas
Interesting that this appeared (AFAIK) first in foreign press – it's the sort of thing that's making overseas invertors very nervous.

I can't help but wonder what else Greenspan had in mind when formulating his recent testimony
3 posted on 03/09/2004 5:31:15 PM PST by M. Dodge Thomas (More of the same, only with more zeros on the end.)
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To: Dog Gone
I'm afraid I don't understand how it could lose money at all. Massive defaults on home loans are not occurring.

The concern is with Fannie's derivative exposure. What triggers it remains to be seen.

4 posted on 03/09/2004 5:38:52 PM PST by Gunslingr3
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To: Dog Gone
I'm afraid I don't understand how it could lose money at all.

They made huge bets that interest rates wouldn't fall and they did.
5 posted on 03/09/2004 5:39:50 PM PST by lelio
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To: Gunslingr3
As I understand derivatives, which isn't much at all, they're a way of hedging risk of price or interest swings. It's like locking in a band of prices for the producer of a commodity. You don't get the advantage of a huge price increase, but you're similarly protected if the price falls.

So, if Fannie was doing this right, it would have been good insurance. If they were speculating in the derivative markets themselves, the controlling officers should be summarily shot.

6 posted on 03/09/2004 5:46:53 PM PST by Dog Gone
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To: M. Dodge Thomas
Who's going to jail over this?
7 posted on 03/09/2004 5:52:30 PM PST by Ken H
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To: Dog Gone
> I'm afraid I don't understand how it could lose
> money at all. Massive defaults on home loans are
> not occurring.

Poor derivative bets on cash flow hedging operations.

It's standard practice to not to report these losses (or gains) in statements of current financial position.

But some people (myself included) would argue that this misstates the long-term prospects of such organizations - especially if such losses (as in this case) are in the tens of billions of dollars and rising rapidly.

Greenspan and Snow (and the current administration, which really can’t be held responsible for this problem) are really over a barrel on this one – they don’t want to exacerbate te moral hazard inherent in investors believing that the government will provide unlimited support to such institutions if they get into trouble but also don’t want to spook (especially overseas) investors.

The bottom line is that taxpayers are probably on the hook for this one.
8 posted on 03/09/2004 5:53:05 PM PST by M. Dodge Thomas (More of the same, only with more zeros on the end.)
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To: Gunslingr3
"The concern is with Fannie's derivative exposure"

Useful link. Thanks.
9 posted on 03/09/2004 5:57:35 PM PST by M. Dodge Thomas (More of the same, only with more zeros on the end.)
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To: Gunslingr3
I'm afraid I don't understand how it could lose money at all. Massive defaults on home loans are not occurring.

The concern is with Fannie's derivative exposure. What triggers it remains to be seen.

Do a Google Search on Barings Bank.

Barings was a 200 year old Merchant Bank that was so powerful that Bismark said "There are six great powers upon the continent of europe; England, France, Germany, Austria, Russia and Barings".
In 1995 one of their bond traders in Hong Kong trading futures/derivitives, bankrupted the bank with a few bad positions. There is no regulation at all on what Fannie Mae has been trading, no limits, and everyone in the world expects the govt. to back their play without limit.

So9

10 posted on 03/09/2004 5:59:21 PM PST by Servant of the 9 (Goldwater Republican)
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To: M. Dodge Thomas
There is an article on CNNFN today that is relevant to this topic. It's scary stuff - here's an excerpt:

" U.S. Treasury Secretary John Snow took direct aim Tuesday at mortgage finance firms Fannie Mae and Freddie Mac, repeating previous warnings to investors that government-sponsored enterprises are not financially backed by the U.S. government. "

http://money.cnn.com/2004/03/09/news/companies/snow_gse.reut/index.htm



11 posted on 03/09/2004 6:00:39 PM PST by TXLibertarian
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To: Servant of the 9
I got out of the derivatives business in the early 1990's. At that point world-wide derivative notional values were larger than the combined GDP of the G-7 countries. That exposure has grown exponentially since then.
12 posted on 03/09/2004 6:04:45 PM PST by groanup (We sleep soundly because rough men stand ready to die for us.)
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To: Dog Gone
I'm afraid I don't understand how it could lose money at all. Massive defaults on home loans are not occurring.

= = = = = = = = = = = = = = = = = = = = = = = = = = = = = =
The primary risk Fannie and it's companion agency Freddie Mac face is not default risk, but risk of losses due to fluctuation of market interest rates. Both of these firms "hedge" their interest rate risk by buying and selling interest rate derivatives (see, e.g.,
http://www.strategies-tactics.com/derivatives.htm

and, for some specific application to GSE's see discussion towards the middle of:
http://www.lewrockwell.com/north/north96.html

(with interesting reference sites linked, even if you blow off the alarmist rhetoric)
13 posted on 03/09/2004 6:07:47 PM PST by Blue_Ridge_Mtn_Geek
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To: TXLibertarian
"There is an article on CNNFN today that is relevant to this topic. It's scary stuff - here's an excerpt:

" U.S. Treasury Secretary John Snow took direct aim Tuesday at mortgage finance firms Fannie Mae and Freddie Mac, repeating previous warnings to investors that government-sponsored enterprises are not financially backed by the U.S. government. "

Well, Snow would no doubt like to convince international investors that such "guarantees" aren't worth the paper they aren't printed on, but that the case of actual US Government obligations is an entirety different matter.

Problem is, people running the sort of current accounts deficits we are don't have much room to maneuver, even a small decrease in overseas investors' confidence can translate into interest rates rises which dwarf the costs of bailing out Fannie Mae and Freddie Mac.

(The contra argument is that letting investors in these institutions take their lumps would demonstrate to investors the US is serious about getting it's house in order – the problem is that our current policy of big tax cuts *and* big deficits is a pretty convincing demonstration that ours is a disorderly house indeed.)
14 posted on 03/09/2004 6:28:11 PM PST by M. Dodge Thomas (More of the same, only with more zeros on the end.)
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To: M. Dodge Thomas
That explains all the advertising and PR they've been buying/using recently.
15 posted on 03/09/2004 6:51:04 PM PST by ReleaseTheHounds
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To: M. Dodge Thomas
Yet here in Texas they are running ads non-stop on both radio and TV. What the heck is going on?
16 posted on 03/09/2004 7:35:52 PM PST by txzman (Jer 23:29)
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To: M. Dodge Thomas
It's just a matter of time until many lending institutions will probably have to start foreclosing on homes. The people who's jobs have been outsourced are going to be losing their homes before long. The states that have had huge losses of jobs to outsourcing are really going to get clobbered. If a lot of union factory workers got loans through their credit unions, It could put them on shaky ground too. With the factories gone there are no more workers to pump up their cash flow.

Many people have just about exhausted all of their resources trying to keep from losing their homes, while others may be in foreclosure right now. Fannie Mae and Freddie Mac will undoubtedly have their share of foreclosures too. No doubt these people have maxed out their credit cards trying to stay afloat, so those unsecured credit card balances will be a total loss to the credit card providers. Factor in auto and furniture loans going into default and the bottom could drop out of the credit industry. Just how bad it will be, I don't know. We'll have to wait and see.

I hope I'm wrong, but I don't see how these people are going to recover. It's probably too late for many of them already. IMHO.

17 posted on 03/09/2004 7:43:25 PM PST by NRA2BFree (The heart of the wise inclines to the right, but the heart of the fool to the left. Ecc 10:2)
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To: Jimmy Valentine
You may want to see this. It's definitely not good news to an already shaky mortgage industry.
18 posted on 03/09/2004 8:16:18 PM PST by NRA2BFree (The heart of the wise inclines to the right, but the heart of the fool to the left. Ecc 10:2)
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To: Dog Gone
It isn't the mortgage defaults as much as the early payoffs that upset one side of the derivative package. This creates the prospective loss.

The question is whether rate increases will offset the prospective loss. Probably will, but if they are not careful they will trash the real estate market.

regards.

19 posted on 03/10/2004 10:49:13 AM PST by Jimmy Valentine (DemocRATS - when they speak, they lie; when they are silent, they are stealing the American Dream)
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To: NRA2BFree
Fannie and Feddie are houses of cards
20 posted on 03/10/2004 10:53:20 AM PST by petercooper (Florida 2000: Bush 2,912,790 - Gore 2,912,253)
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To: NRA2BFree
You are right as rain and thanks for the ping. What will be interesting is to see what happens when Fannie/Freddie raise rates to cover the derivative risk. This could trash the sale/re-sale market and leave many people "upside down" in their houses. A spate of foreclosures could exacerbate the derivative risk by unbalancing one side of the hedge.

"Fasten your seatbelts; we're in for a bumpy night." - Betty Davis.

Regards,

21 posted on 03/10/2004 10:53:53 AM PST by Jimmy Valentine (DemocRATS - when they speak, they lie; when they are silent, they are stealing the American Dream)
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To: Jimmy Valentine
You are right as rain and thanks for the ping. What will be interesting is to see what happens when Fannie/Freddie raise rates to cover the derivative risk. This could trash the sale/re-sale market and leave many people "upside down" in their houses. A spate of foreclosures could exacerbate the derivative risk by unbalancing one side of the hedge.

"Fasten your seatbelts; we're in for a bumpy night." - Betty Davis.

You're welcome! I figured you'd want to read this article. At least we see the writing on the wall and can adjust our finances if necessary.

I do agree with you about the bumpy ride. It's not going to be fun.

22 posted on 03/10/2004 12:59:54 PM PST by NRA2BFree
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To: NRA2BFree
"It's not going to be fun."

Indeed not. I went through the meltdown of the late 1980's - early 1990's and do not want to do it again, but it begins to look as though we will all have to.

My end of the banking business (Lending) has been destroyed by short run maximizers who keep creating these disasters over and over again.

Damn nonsense!

Regards, and keep your head (and wallet) down and safe.

23 posted on 03/10/2004 1:30:42 PM PST by Jimmy Valentine (DemocRATS - when they speak, they lie; when they are silent, they are stealing the American Dream)
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To: dix; Eaker; Flyer; humblegunner
Fannie Mae may face $24bn derivatives losses

So that's what Fannie was up to when Dix was sidelined! Guys, we need to confiscate her cell phone.
24 posted on 03/10/2004 1:31:35 PM PST by Xenalyte (I may not agree with your bumper sticker, but I shall defend to the death your right to stick it)
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To: Dog Gone
If they were speculating in the derivative markets themselves, the controlling officers should be summarily shot.

Don't worry, you will be bailing them out if they are.

25 posted on 03/10/2004 11:19:40 PM PST by AdamSelene235
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To: Xenalyte; dix
So that's what Fannie was up to when Dix was sidelined!

I saw Fannie yesterday. She is feeling really bad about this. She said she will deal only with money market funds and tax free muni's for a while.

26 posted on 03/11/2004 12:47:10 AM PST by Flyer (Don't abandon our military - Re-elect President Bush!)
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To: Flyer
I figured she probably got in this deep accidentally, since she's usually quite the level-headed beagle when it comes to financial wheelings and dealings.
27 posted on 03/11/2004 6:36:52 AM PST by Xenalyte (I may not agree with your bumper sticker, but I shall defend to the death your right to stick it)
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