Fannie, Freddie and Ginnie: Paying for Design Flaws

Updates on what this is going to cost you and me.

Let’s start with Fannie Mae (NYSE:FNM), the government-sponsored enterprise that was allowed to function as a quasi-private company from 1968 to 2008 and is currently under conservatorship of the Federal Housing Finance Agency. Prior to conservatorship, Fannie earned a profit two ways. First, it used borrowed funds to purchase mortgages that it held directly. Because investors perceived the GSE’s debt to be implicitly backed by the federal government, Fannie’s borrowing costs were very low, and it had an incentive to engage in arbitrage on a huge scale, borrowing cheap and buying as many mortgages as regulators would allow. As of June 2009 these assets came to $793 billion. Second, Fannie would bundle mortgages into securities on which it provided a guarantee of timely payment of principal and interest, in exchange for which it received a modest fee, and assumed a staggering off-balance-sheet liability. As of June 2009, Fannie’s guarantees involved an additional notional liability of $2.4 trillion. Fannie’s equity was never remotely sufficient to make such guarantees credible, and this game, too, is best interpreted as arbitraging an implicit government obligation to pick up the tab should things turn sour.

On August 6 Fannie reported (hat tip: Calculated Risk):

Total nonperforming loans in our guaranty book of business were $171.0 billion on June 30, 2009, compared with $144.9 billion on March 31, 2009, and $119.2 billion on December 31, 2008.

This doesn’t mean that taxpayers are now out $171 billion, because the salvage value on these properties is not zero. On the other hand, more defaults could be ahead.

Fannie’s GSE brother, Freddie Mac (NYSE:FRE), had over $2 trillion in mortgages held outright or guaranteed, last time I checked. Freddie reported $15 billion in non-performing assets that it holds outright and an additional $62 billion in non-performing assets on which it has issued guarantees (Table 2 in their second-quarter 10Q). But on top of this is the imminent bankruptcy anticipated from mortgage originator Taylor, Bean & Whitaker, following last week’s allegations of “irregular transactions that raised concerns of fraud”. Freddie Mac filed this report (hat tip: CR):

TBW accounted for approximately 5.2% and 2.7% of our single-family mortgage purchase volume activity for full-year 2008 and the six months ended June 30, 2009, respectively. We are in the process of determining our total exposure to TBW in the event it cannot perform its contractual obligations to us. The amount of our losses in such event could be significant.

And the Federal Housing Administration is stepping in where Fannie and Freddie leave off. A recent report from the Office of Inspector General noted that the FHA’s current single-family insured exposure totals over $560 billion and invites preventable fraud. TBW was the third biggest originator of FHA loans, with the overall delinquency rate on FHA-guaranteed loans now up to 7.42%.

Then there’s the $1 trillion in mortgage exposure that Ginnie Mae is about to take on.

Paying for design flaws

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