Fannie FNMA in Big Trouble

"One of the paradoxes of speculation in securities is that the loans that underwrite it are among the safest of all investments. They are protected by stocks which under all ordinary circumstances are instantly saleable, and by a cash margin as well....A few firms made this decision: instead of trying to produce goods with its manifold headaches and inconveniences, they confined themselves to financing speculation...This was, possibly, the most profitable arbitrage operation of all time."

- The Great Crash - published in 1954 J.K.Galbraith

Fannie Mae is an absolutely gargantuan organization with approximately $1 trillion in assets and $1 trillion in notional (or face value) derivatives exposure, yet has only $26 billion of equity. Said differently, $26 billion of equity is holding up an asset and derivatives book that is about 20% of GDP.

That gives you some idea of how big the problems can get if something bad, in fact, happens.

From the recently released report on FNMA:

"As of December 31, 2003, the balance in AOCI (“accumulated other comprehensive income” – where declines in derivative market values have been segregated to avoid impacting reported earnings/retained earnings) reflects $12.2 billion in deferred losses relating to cash flow hedges. Furthermore, carrying value adjustments of liabilities relating to fair value hedges amounted to
$7.2 billion as of that date"....

"At December 31, 2003, Fannie Mae
had notional of $1.04 trillion in derivatives, of which a notional of only $43 million was not in hedging relationships"…

"The matters discussed herein raise serious doubts as to the validity of previously reported financial results, as well as adequacy of regulatory capital, management supervision, and overall safety and soundness of the Enterprise.”

An excellent article by Doug Noland on the GSE's, FNMA et al..

http://www.investmentrarities.com/thebestofdn10-05-04.html

Comments