Uncle Sam’s Dirty Little Secret

If a tree falls in the forest and nobody is there to hear it, does it make any noise?

If an agency is sitting on billions in losses but nobody asks about it, can we forget about it?

If an entire group of banks is sitting on hundreds of billions more in losses, and the media is not even aware of this banking system, can we pretend they don’t exist?

Oh, if only we could, perhaps our economic life would be so much simpler.

While Uncle Sam and the media can choose to overlook these institutions, the losses are real and will serve as a drag on our economy and nation for the foreseeable future. Yet, they receive very little attention. Fortunately, Bloomberg shed a hint of light on part of this problem today in writing, Fannie Mae, Freddie Mac in Limbo as Geithner Seeks More Time:

Fannie Mae and Freddie Mac will remain in limbo as the U.S. Treasury secretary said the government doesn’t have time now to deal with the future of the two mortgage-finance companies it seized in September.

“We did not believe that we could at this time — in this time frame — lay out a sensible set of reforms to guide, to determine what their future role should be,” Treasury Secretary Timothy Geithner told the Senate Banking Committee in Washington today. “We’re going to begin a process of looking at broader options for what their future should be.”

Doesn’t have time or doesn’t want to admit that these agencies represent an ongoing and enormous drag on our economy? How so? Fannie and Freddie hold 50% of the mortgages in our country. These entities are most likely sitting on hundreds of billions in embedded losses currently with limited prospects to generate real revenue. They have no viable business model at this point in time. As a result, rather than entering into an unpleasant and economically harmful dialogue, Geithner chooses to sweep this under the rug. How can Tim do this? Because Uncle Sam has allocated, if not necessarily set aside, funds for these agencies to offset future losses. As Bloomberg highlights:

The remainder of Fannie Mae and Freddie Mac’s $400 billion U.S. Treasury lifeline should still be “sufficient” until the government decides how to restructure the companies, Federal Housing Finance Agency Director James Lockhart said in June 3 testimony to a House subcommittee. Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac have already requested $84.9 billion in taxpayer aid through the Treasury’s program to buy the companies’ preferred stock to keep them solvent.

Over and above swimming in a sea of losses, both Freddie and Fannie are effectively rudderless. Fannie Mae’s acting CEO, Herb Allison, was recently appointed to oversee management of TARP funds at Treasury. Freddie Mac’s acting CEO, John Koskinen, had resigned and only returned when beseeched. While Koskinen has committed to retaining the role of chairman of Freddie, he can’t get out of his daily Freddie Mac responsibilities quickly enough as the WSJ reports, Freddie’s Accidental CEO Tries to Shed Job.

The dirtier little secret hidden by Uncle Sam is embedded within the Federal Home Loan Bank system. Why? After Uncle Sam, the FHLB system is the second largest creditor in our country with approximately $1.2 trillion in outstanding debt. While Freddie Mac (FRE) and Fannie Mae’s (FNM) portfolios are chock full of agency mortgage-backed securities (MBS backed by conforming size loans), the portfolios within the FHLB system (12 regional banks) are stuffed with Jumbo mortgages, Alt-A, pay-option ARMS, and sub-prime. In short, lots of toxic assets and lots of embedded losses hidden by the artful deceit of the relaxed mark-to-market accounting standard.

Where are we going with these future wards of the state? I project that in 2010, we will see these 14 entities (Freddie and Fannie and 12 regional FHLBs) combined into one large government owned housing finance entity.

Shhhhh . . . don’t tell anybody!!

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

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