I'm afraid that turning over this rock is going to expose a 'bottomless pit' - a 'pit' that will eventually require the US gov't to throw piles of tax money down in an attempt to fill it in !
If you remember, some time ago Scorp raised the question of why private lenders would continue to write new mortgages if the real estate market in certain areas was really poised for a decline. In theory at least, if a private lender writes a new mortgage on a house with a 5% down payment, and the local real estate market declines 10%, the private lender holding the mortgage is potentially facing a borrower default situation where the amount of money the lender can recover via repo and auction is less than the outstanding mortgage balance (especially after foreclosure costs are added). Therefore private lenders typically 'sell' these mortgages to a third party ... with Fannie Mae being the biggest third party mortgage buyer, holding 1 of every 5 US mortgages. By 'selling' the mortgage to Fannie Mae, the private lender transfers the potential loss risk to Fannie Mae.
On the other side of the equation, Fannie Mae then 'repackages' the mortgages it is holding into quasi-gov't backed bonds, which it then sells in the securities market. Basically, by issuing these bonds, Fannie Mae is committing to paying x dollars in interest over a period of y years to the purchasers of these bonds. In theory, the monthly payments made by homeowners gets channeled through the private lender who wrote the mortgage (and who still services it, for a fee), then on to Fannie Mae, then on in turn to the purchasers of Fannie Mae bonds in the form of bond interest, with enough money left over to cover everybody's expenses.
However, if a significant number of the mortgages Fannie Mae is holding go belly-up, and especially if the amount of money that can be recovered via repo and auction falls short of the outstanding balance of the mortgage, then Fannie Mae is stuck between a rock and a hard place. On the one hand, Fannie Mae is obligated to keep making interest payments on its bonds. On the other hand, not only has Fannie Mae lost the monthly cash flow from each belly-up mortgage, but it also must 'eat' the losses re the amount it paid to 'buy' the mortgage from the private lender versus the amount actually recovered via repo and auction. This is even more of an issue considering that, due to political pressure from HUD, Fannie Mae has over the past few years become a big player in the sub-prime mortgage market, where the probability of a homeowner default on their mortgage is much higher and where a 'gap' between outstanding mortgage balance and auction resale value is more likely (something like 30% of all sub-prime mortgages are now held by Fannie Mae or cousin Freddie Mac).
The conspiracy theorists would make the case that Fannie Mae has been the 'victim' of a huge number of homeowner mortgage defaults already, as well as having taken significant 'gap' losses when the auction price of the repoed property falls short of the outstanding mortgage principal in areas with declining / undesireable real estate markets, and that the situation is rapidly accelerating. The conspiracy theorists would also make the case that Fannie Mae's failure to issue financial statements to the investment world for more than a year is a bold-faced attempt to keep Fannie Mae's actual financial situation under wraps, to both avoid providing hard evidence that the 'housing bubble' is collapsing, and to avoid a breach of investor confidence i.e. Fannie Mae bondholders running for the exits.
If any other business entity had failed to issue financial statements for this long, not only would their stock shares have been de-listed but huge investigations would be underway both in terms of finances and in terms of criminal wrongdoing. However, Fannie Mae continues to 'skate along' business as usual, with new rules apparently being made up as the need arises.
On the other hand, Fannie Mae is a Gov't Sponsored Entity i.e. a gov't chartered business, which implies (I'll repeat, implies, but does not guarantee in writing) that the US gov't will be responsible for making sure that Fannie Mae's bonds will not ever go into default. It is this implied guarantee which allows Fannie Mae to still sell its bonds while agreeing to pay a lower interest rate than if the same bonds were issued by a private corporation. But this also means that US taxpayers are potentially on the hook to make good billions of dollars worth of Fannie Mae losses (potentially making the S & L bailout look like pocket change). It also potentially means that if/when the buyers of mortgage backed bonds acknowledge the increasing risk, that they are going to demand higher interest rates in exchange for that risk, which will send mortgage and other long term interest rates skyward, which will in turn collapse the housing/mortgage market.
curioser and curioser ...
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