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Fannie & Freddie: Shouting ‘fire’ in a packed auditorium

Panic over the state of Fannie and Freddie may have been overplayed, but more transparency over their role in US housing should be welcomed.

It seems remarkable, given the lurid headlines and negative reactions, that the Lehman Brothers’ equity research on Fannie and Freddie published at the beginning of July suggested that the agencies’ underperforming stocks were good value over the long term.

Not many in the market, especially not the authors of the report, believe that new accounting rules (FAS 140), which would require many billions of additional capital, would be imposed on the government-sponsored enterprises. Nevertheless, the market decided to pick up on the vague possibility of an additional $46 billion and $29 billion of capital being required for Fannie and Freddie respectively, and ignore the protests from the government sponsored enterprises’ regulator, OFHEO, that it would not countenance such new accounting regulations.

It seems that the market was searching for any good reason to hammer these two entities. And it received plenty of help from former Federal Reserve Bank of St Louis governor William Poole when he said that the GSEs were technically insolvent. Poole’s comments have some credence. On a fair-value basis, their liabilities are probably far greater than their assets. Nevertheless, his comments were akin to shouting “fire” in a packed auditorium. The market sold off dramatically and a so-called bail-out was quickly organized.

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