Fannie and Freddie: $12 trillion mortgage twins

Wednesday 09 July 2008

Ongoing turmoil in the US economy is taking a heavy toll on the nation's biggest government-backed mortgage agencies. Shares of "Fannie Mae" and "Freddie Mac" have plummeted in recent days amid fears they could soon face a cash crunch.

 

They sound like a nice couple with whom you might share a beer and easy banter at a summer barbecue.

          

But don’t be fooled by the folksy nicknames. Fannie Mae and Freddie Mac are, in fact, shorthand for two titanic US government-backed agencies: the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.

 

Together, they constitute the twin pillars of the US home-loan industry, their portfolios valued at a dizzying $12 trillion (that’s a 12 with 12 zeros after it) - or nearly half the value of all American home mortgages.

 

On Monday, the agencies’ share prices suffered their worst fall in a month of steady erosion, tumbling 16% and 18%, respectively, to their lowest levels in over a decade. They have plummeted an average of 60% since the start of the year.

 

What triggered the nosedive was a warning from the Wall Street investment bank, Lehman Brothers, that Freddie and Fannie may have to raise tens of billion of dollars in extra capital to shore up their businesses under proposed new accounting rules.

 

The stocks regained some of their lost ground on Tuesday, after some of worst fears were dispelled. But much of the psychological damage had already been done.

 

Investors have been driven to new heights of neurosis in recent months, as record writedowns by the world’s biggest financial institutions - $400 billion and counting – have fed fears of more fallout to come.

 

That message was reiterated Tuesday by Federal Reserve chief Ben Bernanke. He said that while he foresaw further tumult in credit markets in the months ahead, the Fed stood ready to administer first aid and prevent new flare-ups with a mix of tougher regulation and lending.

 

As the New York Times points out, Fannie Mae and Freddie Mac have long been regarded as a “backstop” for the US economy. According to the paper, the brutal drop in their shares, coupled with the continuing bad news out of the US economy, is darkening the mood among investors and heightening fears that “the current housing slump will last longer, and prove more severe, than initially feared”.

 

The upshot for Fannie Mae and Freddie Mac, most observers agree, is a climate in which they could find it very tough to raise new capital in a crunch, should the need arise.

 

According to an old Wall Street axiom, “As General Motors goes, so goes the US economy”. Today that might apply equally well to Fannie Mae and Freddie Mac. They are symptomatic of the broader problems afflicting the US economy, as banks struggle against stiff subprime headwinds, home prices fall, and consumer confidence eases.

 

Since late last year, Fannie Mae and Freddie Mac have raised 20 billion dollars to shore up their balance sheets. With more big banks likely to report new losses as the quarterly earnings season gets underway, we may shortly witness another frantic scramble for fresh capital.

 

While bankruptcy isn’t a real threat for the government-sponsored likes of Fannie and Freddie, chances are that, until things settle down, you won’t be bumping into them at the Sunday barbecue anytime soon.