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Paulson's Freddie and Fannie Hangover

Written By Brian Hicks

Posted August 12, 2008





In the annals of “too big to fail”, there have only been two companies in my mind that had to be bailed out.

They are Freddie and Fannie, even though longer term they should be broken up into several much smaller pieces.

However, letting them go under in the blink of an eye would simply be unthinkable.

Without them, the housing market would go into a total deep freeze—-10 times worse than it is right now.

After all, Freddie and Fannie are the mortgage business these days with over 70% of the market. Besides if we stiff China on the $400 billion they have wrapped up in these two companies, they might cut us off completely. Oh my…now that would be unthinkable.

But despite the government’s now explicit backing of these two miscreants, neither one of them is even close to being out of the woods yet—not by a long shot.

So when I heard Hank Paulson tell Tom Brokaw this weekend that “”We have no plans to insert money into either of those two institutions”, I had to laugh.  It’s preposterous on the face of it.

That’s because what’s going on at Freddie and Fannie is just like the rest of mortgage mess: It is a slow-motion train wreck that can’t be stopped. And while Freddie and Fannie might not need any “money injections” today, at some point they surely will.

Here’s why.

What first started with sub prime has now worked its way fully up the value chain. Alt-A is toast and now even “prime” mortgages are defaulting at an alarming rate.

That means that the worst is yet to come for Freddie and Fannie and Paulson knows it. 

Beacuse when “primes” begin to default in unexpected numbers, the results will push these two companies even deeper into the pit, since these will be new “unexpected” losses. The numbers of which will be staggering.

Unfortunately, that is exactly what is happening.

From CNNMoney by Les Christie entitled: The next wave of mortgage defaults

“Prime mortgages are starting to default at disturbingly high rates – a development that threatens to slow any potential housing recovery.

The delinquency rate for prime mortgages worth less than $417,000 was 2.44% in May, compared with 1.38% a year earlier, according to LoanPerformance, a unit of First American CoreLogic that compiles and analyzes residential mortgage statistics.

Delinquencies jumped even more for prime loans of more than $417,000, so-called jumbo loans. They rose to 4.03% of outstanding loans in May, compared with 1.11% a year earlier.

And prime loans issued in 2007 are performing the worst of all, failing at a rate nearly triple that of prime loans issued in 2006, according to LoanPerformance.

“The extent of how bad these loans are doing is very troubling,” said Pat Newport, real estate economist with Global Insight, a forecasting firm.

Washington Mutual CEO Kerry Killinger said last month that the bank’s prime loan delinquencies are on the rise. As of June 30, 2.19% of the prime loans issued by WaMu in 2007 were already delinquent, compared with 1.40% of prime loans issued in 2005.

Also last month, JP Morgan Chase CEO Jaime Dimon called prime mortgage performance “terrible” and suggested that losses connected to prime may triple. For the second quarter, the bank reported net charges of $104 million for prime rate delinquencies, more than double the $50 million recorded three months earlier.

Prime loans are just the latest class of mortgages to suffer a spike in failure rates. The first lot to go bad was, of course, subprime mortgages, whose problems set the housing meltdown in motion. Next were the Alt-A loans, a class between prime and subprime loans that doesn’t require strict documentation of a borrower’s assets or income.

Now, as prime loans are added to the mix, the resulting foreclosures could haunt the housing market for a long time, according to Global Insight’s Patrick Newport.

“Home prices will drop for quite a while – maybe several years,” he said.”


Paulson, by the way, also ruled out the idea he was going to stick around for another tour of duty.

He also told Brokaw, “I am very focused on getting everything done I can get done between now and January 19th. I look forward to doing other things next year.”