Everyone’s talking about Fannie and Freddie

The situation with Fannie and Freddie is coming to a head soon. Here are a few links on the chatter in the markets and on the blogosphere:

Fannie, Freddie `Insolvent’ After Losses, Poole Says – Bloomberg

U.S. Mulls Future of Fannie, Freddie – WSJ

Poole: Fannie, Freddie `Insolvent’ After Losses – The Big Picture

Former St. Louis President Poole Calls Freddie, Fannie “Insolvent” – naked capitalism

Saving Fannie and Freddie – Market Movers

Poole: Fannie, Freddie “Insolvent” – Calclated Risk

Former Fed Governor Says “Fannie, Freddie Insolvent” – Mish’s Global Economic
Trend Analysis

My own view? I said it back on May 6th in my post ‘Question: How is Fannie Mae a AAA company?‘:

The GSEs are highly levered organizations, which are suffering greatly in the subprime debt crisis. At the end of 2007, Fannie Mae had nearly $900 billion in assets on only $44 billion in capital. The fair value of its asset base is much lower at the self reported $12.2 billion above. That is a balance sheet 20 times capital — or 80 times, depending on how you look at it. Any way you look at it, if it’s assets suffer only a 5% loss in value Fannie Mae would be completely worthless.

Looking at Fannie Mae and Freddie Mac as a pair, the New York times says:

Some financial experts worry that the companies are dangerously close to the edge, especially if home prices go through another steep decline. Their combined cushion of $83 billion — the capital that their regulator requires them to hold — underpins a colossal $5 trillion in debt and other financial commitments.
–New York Times

Given the fact that subprime defaults are seeping into other classes and that Alt-A resets have not begun in earnest, there are many credit losses to come. How can a company this exposed to the mortgage meltdown, taking this level of losses, that is this levered, and that needs this much capital to shore up its capital base be a AAA rated company?

The only answer is the implicit government guarantee. Fannie Mae and Freddie Mac are too important and too big to fail. In fact, the U.S. government may need to ‘re-nationalize’ these organizations to conduct a clean up of the mortgage mess. This is implied by the New York Times article referenced above. Otherwise, there is no way on earth these companies should ever be rated AAA.