Fannie and Freddie in dysfunctional credit markets

Author: David Kotok, Post Date: December 6, 2007
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We expected the foreclosure, subprime mess to become the central focal point of US politics; it has now done so.

The reason is simple. A single foreclosure on a street impacts the entire population of the street not just the household that lost their home. All nearby property values are hurt. Foreclosures are an indicator of a much larger cohort of trouble.

Half the foreclosures we see are in three states: Florida, Texas and California. You cannot become president of the United States without winning at least two of these three states. Thus we see the presidential race moving to this topic as the premier issue.

Since the peak of adjustable rate mortgage resets is in May 2008, we expect the politics to intensify. Every pol will offer his or her solution as the best. They will blame others for the problem.

They are all shameful. They are reactive and have not been proactive. Now the dysfunctional American political system is trying to play catch up to the dysfunctional credit markets. Such coincidences of timing have ended badly in the past. This is how we get misguided legislative and permanent tax code changes which are launched as temporary solutions. The whole thing is a sad commentary on our system.

And, as we have written twice, the Federal Reserve is held political hostage during this period by the US Senate which will not confirm nor even hold hearings on two nominees for Fed Governor spots let alone a confirmation on a third sitting Governor who is up for reappointment.

Why am I harping on the politics and the threat to the Fed?

There is a fundamental reason. The United States has two nationally franchised mortgage agencies. Fannie Mae and Freddie Mac. They have had their share of troubles as we know. They have cut their dividends and are raising capital through preferred stock issuance into order to strengthen their weakened balance sheets. They are emasculated by the Congressional system that is also one of the main sources of this credit problem. They have a regulator who has no experience in dealing with an asset class that is falling in price. OFHEO price declines are just surfacing in the OFHEO data. What planet are they on?

Note that GSE debt and specifically Fannie and Freddie is held around the world. About $1 trillion is in foreign institutional hands. Those folks are watching our political system fail and they are insecure. The spreads of GSE debt to corresponding treasury debt by maturity have doubled.

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