Counterparties: The most profitable insurer in America

By Ben Walsh
April 2, 2013

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If you’re looking for evidence of just how far the housing market has come since its implosion triggered the financial crisis, consider Fannie Mae. The housing giant seized by US government five years ago reported a record profit of $17 billion for 2012, after a roughly equal loss in 2011. It’s Fannie’s first annual profit since 2006; as  Clea Benson notes, the profit eclipsed that of companies like Wal-Mart, GE and Berkshire Hathaway.

Drilling down into Fannie’s filing gives you a snapshot of the American housing market. The company set aside less to cover future losses on loans it guaranteed ($62 billion, compared to $76 billion in 2011); suffered lower delinquency rates; had higher loan volume and higher fees; and saw the value of its derivatives positions improve. Bill McBride at Calculated Risk pulls out another bright spot: Fannie says that there was a “4.7% increase in home prices in 2012 compared with a home price decline of 3.7% in 2011.”

Fannie’s earnings could have been $59 billion higher, Benson adds. Due to an agreement with Treasury, any net worth beyond $3 billion cannot be retained by Fannie and instead must be paid back to taxpayers. As soon as the first quarter of this year, Fannie could be required to report $59 billion in assets that had previously been written off, and most of that would have to be shipped to the US government to stay under the cap. David Reilly notes that that payment, along with $31.4 billion in dividends already paid to government, would mean Fannie will have paid the Treasury a total of $90 billion. That may look like a large chunk of the $116 billion pumped in by the US taxpayer, but in fact that $116 billion is still going to be outstanding: Fannie’s just paying dividends, here, rather than repaying debt.

It may also be hard for Fannie to repeat the successes of 2012. Matthew Klein notices that Fannie isn’t as hedged as it could be, and wonders how much of this year’s “record profits can be attributed to excessive interest-rate risk”.

Fannie’s current success may keep it in government hands that much longer. Why would the US relinquish control of what Peter Eavis notes is the most profitable insurance company in the country, just as its massive bailout was close to turning a (slight) profit? There’s also the small problem that no one has a real plan for extricating Fannie and Freddie from government control.

Instead, Shahien Nasiripour reports, the rough plan is to create a new public utility to compete with the two companies. That “single securitisation platform” will still be taxpayer-backed. — Ryan McCarthy and Ben Walsh

On to today’s links:

Right On
How paid paternity leave could stimulate the economy – Catherine Rampell

Takedown of a takedown
The problem with David Stockman – Neil Irwin

China
The annual toll of Chinese air pollution: 1.2 million premature deaths – NYT

EU Mess
Ireland: where delinquent mortgages are common, but evictions are rare – Matt Phillips
Cyprus’s finance minister has resigned – Bloomberg

Revolving Door
Former SEC chief Mary Schapiro declares revolving door dead, joins shadow regulator – WSJ
A thorough guide to Promontory, DC’s “shadow regulator” firm – American Banker

Regulators
Why do bank capital rules treat loans as riskier than derivatives? – Sheila Bair

Wonks
What you don’t know about poverty – Lant Pritchett

Contrarian
Is the demand for high-skilled workers actually falling? – Arnold Kling

Says Science
Shakespeare was a tax-dodging grain hoarder – Telegraph

Oxpeckers
You can’t stop ESPN’s economic success, you can only hope to contain it – Economist

Billionaire Whimsy
The London neighborhood so exclusive, it’s empty – NYT

Dubious Milestones
Forget Dow 36,000 — we’ve just hit Bitcoin $1 billion – Verge

Data Points
The benefits of being a philosophy major, and of not being a communications major – Pleas and Excuses

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And, of course, there are many more links at Counterparties.

7 comments

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Ben Walsh offers us two fantastic data points in today’s aggregation:

1st that air pollution in China (more than half of which is generated from coal) shortens the lives (kills would be another way to put it)one million people annually. Human minds don’t measure scale very well. A sensational event like Chernobyl or Fukashima plays very well on TV/internet. It’s just so hard to explain to people that the power we use every day kills more people in a few hours than have ever died because of atomic power generation. Is atomic power safe… god no… it’s just 1,000 times safer than the most common method of power generation in the world.

Data point #2 is that the US could conceivably make all their Fannie/Freddie money back by the end of next year. I wonder if appeals courts will look more favorably on the investors who had their “worthless” common and preferred stockholder rights usurped by the government when the companies were put into conservitorship.

Posted by y2kurtus | Report as abusive

“Matthew Klein notices that Fannie isn’t as hedged as it could be, and wonders how much of this year’s ‘record profits can be attributed to excessive interest-rate risk’.”

Why would you fully hedge in an environment where the Fed has stated that it’s not going to push short-term rates up in the near term and long-term rates are near historic lows?

You’ve got minimal prepayment risk–probably 95% of the people who are creditworthy and not underwater refinanced in the past three to five years, and won’t gain enough from doing so again–dubious spread risk (abiding demand for a declining volume of AAA assets), and very little credit risk.

Hedging is giving up a percentage of profits on the possibility that your expectations are severely wrong. When that possibility declines, hedging should too.

Posted by klhoughton | Report as abusive

This is a new David Stockman. His anti-govt views now go far beyond the sloganeering that all the old Reaganites share. It is more visceral.

Why? I’m guessing the failure of Collins & Aikman, the auto parts company of which he was chairman — and a prosecutor’s misbegotten, eventually abandoned, effort to charge Stockman with fraud in that connection — have had a good deal to do with the development of his attitudes.

Sounds like I should get this book.

Anarcho-capitalism: catch the fever!

Posted by Christofurio | Report as abusive

This is a new David Stockman. His anti-govt views now go far beyond the sloganeering that all the old Reaganites share. It is more visceral.

Why? I’m guessing the failure of Collins & Aikman, the auto parts company of which he was chairman — and a prosecutor’s misbegotten, eventually abandoned, effort to charge Stockman with fraud in that connection — have had a good deal to do with the development of his attitudes.

Sounds like I should get this book.

Anarcho-capitalism: catch the fever!

Posted by Christofurio | Report as abusive

@klhoughton – Klein’s argument is that the environment that you describe is exactly the risk. He’s saying that Fannie and Freddie have shorter duration on the debt that they’ve issued than on the mortgages that they hold. When interest rates increase in the future they therefore face the prospect of significantly higher borrowing costs than today, while payments received on their fixed-rate mortgage assets still reflect lower interest rates. That mismatch would be compounded by the fact that fewer people will refinance low fixed-rate mortgages in a higher rate environment.

I haven’t done the research to know if Klein’s underlying statement about Fannie and Freddie’s asset/liability mismatch is correct. It seems plausible, though, since fixed-rate mortgages are such long-term assets. An extreme form of mismatch between long-term fixed rate assets and short-term liabilities shattered the economics of S&L’s in the late ’70′s and early ’80′s, so we’ve seen it happen before.

Posted by realist50 | Report as abusive

I’m happy to see Fannie and Freddie returning money to the Treasury, but I feel like we ought to step back before we declare victory. Their annual guarantee fees are on the order of 50 bps on new mortgages and 25 bps on their overall portfolios, so the ultimate amount made (or lost) on this business is highly sensitive to changes in default rates and recovery values on defaulted loans. Declaring victory based on 2012 feels akin to judging a reinsurer based on a year with no major hurricanes rather than over an extended cycle.

To get an idea of just how ugly the guarantee business looked during rough periods, check out results in the table on page 12 of this report -
http://www.fhfa.gov/webfiles/24258/gfees tudy_2011_83112.pdf . Many, many years of guarantee fee revenue were lost in a couple years (before even considering losses recognized prior to 2010). Still a tenuous situation, especially since there will always be political pressure to reduce guarantee fees on newly originated mortgages during periods with low defaults.

Posted by realist50 | Report as abusive

I have only to ask why does the Govt continue to sell shares of F&F? If shares are being sold, then Shareholders (taxpayers) do have rights to the profits these companies are earning. The money that the Govt is sacking is not re-captilizing these enterprises as they should (per the terms of the Concervatorship). This is a shell game. What will the money be used for? Where is the accounting ledger for all this – Taxpayers should be upset as they are being duped!

Bring these Enterprises back out of C$ship and let Congress manage their affairs properly. If Congress cannot (or refuses to) manage F&F appropiately, then names should be taken and posted for the next election. In the mean-time, if Congress cannot do their duty, then hire an outside group to properly manage the Enterprises. I believe that their is such a thing as a secondary audit.

Please write your Congress person before this gets too out of hand. Please release Fannie and Freddie from C-ship.

Fannie and Freddie were created by some with very bright minds – it’s a shame that they were pillaged. It is aweful that even as these two Enterprises show how strong they can be, that there is still talk to dismantle them.

Congress not only needs to owe up to what the let happen, but continue working on the solution to better manage and keep solvent these two Shareholder owned companies.

I not, buy up all the remaining shares (current price = $10 for commons and 80% for prefers) and call it quits.

Posted by AYoungAmerican | Report as abusive