Fannie Is In Trouble Again. Shouldn’t You Care?
The latest debacle at Fannie Mae is perhaps the deadliest in its existence as a Government Sponsored Enterprise (GSE). The latest discoveries by the Office of Federal Housing Enterprises Office (OFHEO) could ignite a firestorm that may result in dramatic makeovers at the very heart of the organization. As a corporate treasurer, should you sell your Fannie Mae bonds or should you buy more because the yields are higher? Should you be oblivious of the financial headlines if your goal is to hold your investments to maturity?
Stay the Course: Investors are rightfully concerned with the latest development at Fannie Mae, given the sizable holdings of the triple-A rated agency debt in many bond portfolios. For corporate cash accounts, we have been advising to stay the course in holding agency debt with maturities less than three years. Earmarking for unexpected cash outlays and the intent of minimizing marked-to-market losses may suggest lesser allocations to GSE bonds of longer maturities. In a nutshell, we believe that there is no strong fundamental credit basis to support an outright retreat from the very highly rated agency bonds solely based on the reported management mishaps at Fannie Mae.
The GSE debt issued by the likes of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, are an entirely different class of investments from stocks and subordinated bonds issued by the same companies. In fact, both Moody’s and Standard & Poor’s, two of the nation’s largest credit rating agencies, view the GSE status and their central role in the US government’s housing finance policy as the cornerstone of their agency debt ratings. It is conceivable that Fannie Mae could receive downgrades on its subordinated debt ratings, currently at Aa2/AA-, as the result of the findings, its public agency debt issuance and those of other housing GSEs should remain AAA.
To fundamentally weaken the credit paying ability of Fannie Mae would require an act of Congress to remove its GSE status. To date, even the harshest critics in Washington, and all proposed bills introduced, would not entertain such an idea. Based on the government’s experience handling the Farm Credit System crisis in the 1980s, we believe there is a very good chance that the existing debt holders would be paid in whole even in the very unlikely scenario that Congress took away the GSE status.
Too Big to Fail: What OFHEO uncovered merely confirmed the urgent need for further tightening the processes and procedures at the GSEs to minimize the “moral hazard” on the federal government. Critics have long claimed that Fannie Mae and Freddie Mac, with their quasi-government status and lower funding costs, built tremendous financial leverage on their balance sheets with mortgage portfolios. As of June 2004, the combined agency and mortgage debt issued or guaranteed by the two agencies alone amounted to$4.7 trillion, or 21% of all public and private debt outstanding in the United States. A failure or insolvency by either of the institutions could cause devastating effect on the housing finance sector and worldwide capital markets, and would require costly cleanup efforts by the government.
The OFHEO report detailed the preliminary findings at Fannie Mae, after eight months of investigation, that raised series doubts about the accuracy of GSE’s published financial results going back several years. We fully expect the report would accelerate the government’s effort to increase capital surplus with better command and controls, and more transparent financial reporting, at both Fannie Mae and Freddie Mac to further improve the safety and soundness of the entities. The GSEs may go through the process of extreme makeovers in the years to come. For now, at least, we believe they are too big to fail.
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