May 15, 2008
Freddic Mac: What a Mess
Freddie Mac, one of two United States chartered companies that own or guarantee the bulk of home mortgages, recorded a net loss for the quarter that was reduced by accounting gimmickry. The true loss is close to $2 billion. Freddie Mac is 1) hemorrhaging money, 2) overleveraged, 4) gone through recent management behavior problems, and 4) will desperately need new capital soon to survive. In other words, this company is on the edge of insolvency. Yet Congress has increased Freddie Mac's ability to guarantee "gumbo" mortgages (the upper limit has been increased from $420,000 to $625,000 (or so) and Ofheo, its regulatory authority is considering lowering its capital requirements. Even more astonishingly the stock is trading at around $28 a share. The market is anticipating that Congress will bailout the company if it struggles even though there is no explicit promise or understanding that Congress must do so. This is a case study in moral hazard. Congress has two ways out of the mess -- neither of which it will take. Slaughter the pig rather than dress it up; or open its mortgage guarantee program up to any financial institution that wants to get in the market (make the pig compete for its supper).
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