http://www.atimes.com/atimes/Global_Economy/JG22Dj06.html Jul 22, 2008
Debt capitalism self-destructs (2/4) By Henry C K Liu Fannie Mae is another story. Many of the innovative mortgage options introduced during the early 1980s to revive the weak housing market in a recession were exploited to fuel a housing bubble with excessive liquidity provided by the Federal Reserve, helping low- and middle-income buyer to buy homes their stagnant income could not afford. Fannie continues to operate under a congressional charter that directs it to channel its efforts into increasing the availability and affordability of home ownership for low-, moderate- and middle-income Americans. Yet Fannie Mae receives no government funding or backing, and it is one of the nation's largest taxpayers as well as one of the most consistently profitable corporations until now. The company has evolved to become a shareholder-owned, privately managed corporation supporting the secondary market for conventional loans. Its congressional mandate of keeping homes affordable has since been largely forgotten in favor of an unprecedented boom in the housing market. Yet it continues to operate under a congressional charter that provides it with low-cost funds with only perfunctory oversight from the US Department of Housing and Urban Development and the US Treasury. Fannie Mae has two primary lines of business: Portfolio investment, in which the company buys mortgages and mortgage-backed securities (MBSs) as investments, funding those purchases with debt, and credit guaranty, which involves guaranteeing for a fee the credit performance of single-family and multi-family loans. Overseas debt holders During the housing bubble which it essentially helped create with the Fed easy money, Fannie was highly profitable, with high returns for happy shareholders and lucrative compensation for its executives. Above all, it provided a continuous stream of income and profit for Wall Street and central banks around the world while US homeowners were led down a treachery path of eventual foreclosure. According to data from the Council on Foreign Relations, foreign central banks own $925 billion of debt in the two GSEs. China tops the list with $420 billion in Freddie and Fannie debt; Russia and Japan come in second with a combined $407 billion in GSE debt. Others countries that hold the debt include Singapore, Taiwan, and several cash-rich countries in the Persian Gulf. Fannie's portfolio investment business includes mortgage loans purchased throughout the US from approved mortgage lending institutions. It also purchases MBSs, structured mortgage products and other assets in the open market. The corporation derives income from the difference between the yield on these investments and the low subsidized costs to fund the purchase of these investments, usually from issuing debt in the domestic and international markets. Fannie Mae has $3.46 trillion in MBSs outstanding today, held by a dispersed network of investors, including foreign central banks, topped by China's. The GSEs now only pay lip service to accomplishing its mission to provide products and services that increase the availability and the affordability of housing for low-, moderate- and middle-income buyers by operating in the secondary rather than the primary mortgage market. Fannie Mae purchases mortgage loans from mortgage lenders such as mortgage companies, savings institutions, credit unions and commercial banks, thereby replenishing those institutions' supply of mortgage funds. It either packages these loans into MBSs, which it guarantees for full and timely payment of principal and interest, or purchases these loans for cash and retains the mortgages in its own portfolio. Yet Fannie's role in recent years has been to supply the housing bubble with excess liquidity released by a wayward central bank, by buying at a profit economically unsound mortgages that depended on a continuing spiral of rising home prices way beyond reasonable projection of home buyer income growth. It has turned the US from a nation of homeowners into a nation of foreclosed homes. Fannie Mae is now one of the world's largest issuers of debt securities, the leader in the $14 trillion US home-mortgage market. Fannie Mae's debt obligations are treated as US agency securities in the marketplace, which is just below US Treasuries and above AAA corporate debt. This agency status is due in part to the creation and existence of the corporation pursuant to a federal law, the public mission that it allegedly serves, and the corporation's continuing ties to the US government through a weak oversight link. It benefits from an appearance, though not the essence, of being backed by sovereign credit that borders on outright fraud and protected by the doctrine of too big to fail. Fannie Mae debt obligations receive favorable treatment from a regulatory perspective. Fannie Mae securities are "exempted securities" under laws administered by the US Securities and Exchange Commission to the same extent as US government obligations. Also, Fannie Mae debt qualifies for more liberal treatment than corporate debt under US federal statutes and regulations and, to a limited extent, foreign overseas statutes and regulations. Fund managers who buy GSE debt are protected from fiduciary challenges. Some of these statutes and regulations make it possible for deposit-taking institutions to invest in Fannie Mae debt more liberally than in corporate debt and other mortgage-backed and asset-backed securities. Others enable certain institutions to invest in Fannie Mae debt on par with obligations of the United States and in unlimited amounts. Fannie Mae uses a variety of funding vehicles to provide investors with debt securities that meet their investment, trading, hedging, and financing objectives, not all of which serves the public interest. Fannie Mae is able to issue different debt structures at various points on the yield curve because of its large and consistent funding needs. As the Treasury retired 30-year bonds, these GSE agencies stepped in to fill the void in long term finance. Ideology triumphant The privatization of Fannie Mae and Freddie Mac was an ideological move. It was financially unnecessary as sovereign credit could have funded the entire low-, moderate- and middle-income housing-mortgage needs with no profit siphoned off to private investors and brokers. These agency debt instruments played a crucial role in developing and sustaining the credit bubble in the US that is now coming home to roost. In fact, the funding risk of both agencies was questioned, among many others, by the voice of free-market capitalism, the Wall Street Journal, on February 20, 2002 in an editorial about Fannie Mae's and Freddie Mac's safety, soundness and financial management, characterizing both agencies as risky, fast-growing companies that "look like poorly run hedge funds" . "unduly exposed to credit risk with large derivative positions", and that they "use all manner of derivatives" and "are exposed to unquantified counterparty risk on these positions". Such concerns would have been avoided if both agencies had been funded directly with government credit, and the cost of housing to low-, moderate- and middle-income Americans would have been lower. As it happens, the government is now faced with the prospect of having to bail out these GSEs with public funds. The term "undercapitalization" for financial institutions is merely a sanitized euphemism for insolvency. The real source of the present market turbulence is more than just the waywardness of runaway GSEs sidetracked from their public purpose. It is another symptom of the failure of central banking. The world is now witnessing the slow but steady collapse of the central banking regime that came into being in the US in 1913, which has since failed to fulfill its mandate of managing the monetary system to maintain price stability and full employment. Dysfunctional monetary policies adopted by all central banks, led by the US Federal Reserve, have allowed the market to take capital out of free market capitalism to turn it into a gigantic Ponzi scheme. In the 1990s, the original congressional intent for the GSEs was distorted from making homeownership affordable to low- and moderate-income families to a new role of supporting a housing bubble that enables families to buy homes at prices with mortgages their incomes cannot service. The profit from housing price appreciation went mostly to mortgage originators and banks that bought and sold MBSs to investors who also profited from buying debt with debt collateralized with the debt they bought. Capital suddenly became only a notional value in the market of debt derivatives. Homebuyers bought mortgages with no downpayment, banks and mortgage brokers sold the debt to securitizers who sold it to institutional investors who borrowed using the securities as collateral. The GSEs also became very profitable, leaving homeowners to default on their mortgages as the market turned on them. The whole transaction cycle did not require any capital. Fannie Mae and Freddie Mac, ranked Aaa by the world's leading credit-rating companies, are now being treated by derivatives traders as if they were rated five levels lower because the issuers are pitifully undercapitalized for the size of the debt they issue. Credit-default swaps tied to $1.45 trillion of debt sold by these two biggest allegedly US-backed mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service. The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default has doubled in the past two months. Debt guarantee disregarded Traders are disregarding the government's implied guarantee of GSE debt as credit losses grow and concern rises about the GSEs not having enough capital to weather the biggest housing slump since the Great Depression. Fannie Mae has lost 80% of market capitalization value in the first half of 2008 on the New York Stock Exchange; and Freddie Mac lost 70%. The two GSEs reported combined operating losses of more than $11 billion, and have raised more than $20 billion new capital since December 2007. After Lehman Brothers Holdings Inc released a report on June 7, 2008, saying a new accounting rule may require the GSEs to raise another $75 billion in new capital, Freddie Mac shares dropped another 18% and Fannie Mae fell 16%.
