Friday, July 11, 2008

Fannie and Freddie Doomsday Scenario

Having put the distraction du jour to bed, it's time to get back on mission and address yet another bit of "end of the world as we know it" gossip.
Fannie Mae and Freddie Mac are government-sponsored enterprises that help the mortgage market function by purchasing pools of loans and packaging them into securities. If one or both couldn't function, the result would be chaos.

At the end of last year, Fannie alone had packaged and guaranteed about $2.8 trillion worth of mortgages, approximately 23% of all outstanding U.S. mortgage debt. And these securities are highly rated and sold to investors all over the world.

"If Fannie or Freddie failed, it would be far worse than the fall of [investment bank] Bear Stearns," says Sean Egan, head of credit ratings firm Egan Jones. "It could throw the economy into depression or something close to it."
Fannie and Freddie are among the most highly-leveraged companies around, meaning the amount of capital they have on hand is nowhere close to the level of assets they control. However, as a practical matter, the government can't let these institutions fail because they are being counted on to help fix the mortgage mess. As per my favorite new coinage from David Mills, yet another "house of cards built on a foundation of meringue".