GSEs: Fierce competition. Fierce

December 9, 2005 | Congress, Fannie Mae, GSEs, Legislation and policy, Scandal

My sadistic high school gym teacher liked his charges to hurt.  In wrestling, which he occasionally made us do, his goal seemed to be to create pain (which he perhaps thought toughening).  Blood was best, but failing blood sounds of effort and anguish.  Confronted with these rules, my best friend and I agreed to reciprocity: he’d pin me, while I groaned through the contortions, and then for the next fall I’d pin him with appropriately triumphant grunting.


That was us, except neither of us had any muscles


We soon realized that to sell the coach we really were in pain, our moans had to be artfully modulated.  Theatrical cries and shrieks would not do; better was the strangled cry, as if we were stoic Spartan youths really suffering but manfully holding it in.


Daniel H. Mudd, Fannie Mae’s chief executive, acknowledges that the company must change the way it does business. (By Lois Raimondo — The Washington Post)


To hear the noises emerging from Fannie Mae [blog archive here — Ed], as showcased in this sympathetic Washington Post article, one would think that there’s no need whatsoever to regulate their balance sheets or business lines, because they’re facing fierce competition.  




Struggling through the aftermath of multibillion-dollar accounting scandals, officials at Fannie Mae and Freddie Mac say their most difficult decisions may lie ahead. With stiffer competition from other companies and the changing tastes of home buyers in the types of loans they want, the companies face a choice between moving into riskier types of investing and acknowledging to stockholders that their potential for growth is limited.


Translation: If you choke our balance sheet’s growth, that will hurt our stockholders. Ow.


Why might growth be limited?


Congress is considering legislation that would give a new regulator for Fannie Mae and Freddie Mac varying levels of authority to scale back the size of their holdings.  A Senate proposal would limit the kinds of assets they can hold.


Fannie Mae and Freddie Mac have already been forced to become smaller to satisfy regulatory requirements, shedding a combined $200 billion in portfolio holdings.



Market share goes down when the regulator makes you shrink your balance sheet ….


The companies’ earnings, it was later disclosed, were inflated through accounting techniques that masked some investment losses.


Top executives, including [well-compensated former CEO Franklin] Raines, were forced out, and the companies had to remove a combined $16 billion in profit from their books. Freddie Mac officials say they are nearing the point where they can produce reliable financial results. Fannie Mae is further behind and remains the subject of several federal investigations.


Might there have been any connection between massively increased balance sheet, systemic risk exposure (playing the yield curve with huge Federal exposure), and those accounting scandals?


Their investment portfolios, which grew rapidly in the 1990s, were a major source of the accounting violations at both companies.


There’s no need to do any more to rein in the GSEs, they are thoroughly chastened (contrition is free):


In either case, company officials say, the business model that has generated record profit in recent years — buying standard 30-year mortgages from banks so bankers would have more money to lend — must change.


“Where in the olden days, you had a choice of selling your mortgage to Fannie Mae or Freddie Mac, in the future, there are lots of alternatives,” a fact that has prompted a search for ways to diversify, Fannie Mae chief executive Daniel H. Mudd said in a recent interview.


Translation: no need to restrain our duopoly, Congress, the fierce market will fiercely do it.


“It’s unlikely Fannie Mae and Freddie Mac will ever see the market shares they saw in the early 2000s,” said [Dale Westhoff, Bear Stearns’s senior managing director of mortgage research].  “We will continue to see a higher share of adjustable-rate mortgages [which currently are outside the GSEs permissible assets — Ed.] than we’ve seen historically.”


Fannie Mae and Freddie Mac are not willing to let the market pass them by. Executives of both companies argued that they will have to adapt to fulfill their government-chartered mission to keep money flowing into the housing market.


With Spartan stoicism …


CEO Mudd is bravely soldiering on:


“As we look at our business, we realize we have a special role to fulfill in the market,” Mudd said. “Various strategies we may consider clearly need to be examined in terms of our mission to support the market and help low- and middle-income families.” Mudd said that after the firm puts its accounting problems behind it, it will “participate in more markets with more products . . . and more flexible products for people with a credit blemish on their record and for first-time minority home buyers.”


Freddie Mac already has stepped up its investment in adjustable-rate mortgages, although about 80 percent of its holdings still are long-term, fixed-rate loans.


But that market is fierce:


“The market is so competitive that even if our favored and friendliest customer sees us as being off by a [tenth of a] point, they’re going to sell the business to somewhere else,” Mudd said.


A small word of advice, Mr. Mudd: be careful with that argument.  If it’s true that customers move for ten basis points, and you aren’t capturing big market share, then you aren’t delivering rates below your competition, and thus not really benefiting low-income households, and if that’s so …


Just why do you receive $6-10 billion a year in implicit Federal subsidy?


“The Press, Watson, is a most valuable institution, if you only know how to use it.” 

— Sherlock Holmes, The Adventure of the Six Napoleons, page 191