February 21, 2002
From the desk of Mindles H. Dreck:The WSJ Steps in It
Yes, I'm back. I have no air travel stories to tell other than my return flight was delayed by some sort of dispute between a woman in first class wearing a shaggy purple overcoat and her granddaughter in coach (way back) sporting spiky purple hair and multiple face piercings. I got a good look at the latter because she flounced (I love that word) up and down the aisle several times to respond to her grandmother, who commandeered the plane's public address system. It was just as well that the grandmother refused to enter the coach section. I surely would have had a sneezing attack if she brought that purple angora abomination anywhere near my aisle seat.
Enough of that. I return to find that Yesterday's Wall Street Journal has done a Krugmanesque hatchet job on two huge financial institutions. In an article entitled Fannie Mae Enron, the Journal takes on its pet peeve, GSEs (Government Sponsored Enterprises). In essence, the article is a long Ad Enronum attack on "Fannie Mae" and "Freddie Mac", huge financial entities that make markets in mortgages and were originally created by federal charter.
Readers of this blog will know that I cast a suspicious eye on public enterprises and government guaranties (or, in this case, the appearance of a guaranty). However, it does not logically follow that that any entity with public support is automatically evil. Government control or subsidy creates hazards, the entities in question may or may not fall into these hazards.
The editorial makes several assertions about Fannie Mae and Freddie Mac, among them:
1) "The taxpayers are on the hook" for their debt
2) They borrow, between them, $2.6 Trillion
3) They have such a poor handle on their derivatives borrowing they had to restate their net worth by over $7 billion.
4) Their financial disclosure is sub-standard
5) They have been cutting back on credit insurance
6) They do not disclose the counterparties of their derivatives trade (in addition to the price risk in a derivative their is a risk that the entity on the other side of the contract defaults)
7) They operate under opaque yet lenient risk-based capital rules
The WSJ even suggests congressional hearings on the basis of the above.
The first three of the above arguments are just false. The next four don't stand up very well to scrutiny.
1) There is no government guaranty. There is a perception in the market that the government would support these entities if necessary (probably true) but there is nor formal government guaranty of their debt. The appearance of the guaranty conveys an enormous business advantage to them but doesn't put taxpayers on the hook any more than they are for Citibank.
2) The total debt of FNMA and FRE is $1.3 Trillion, not $2.6 Trillion. If the Journal has used a new method to measure leverage or define debt, they do not describe it.
3) The derivative restatement was a result of adopting new accounting standards (FAS 133). These new standards are, to say the least, controversial, but the comparison between last year's and this year's accounting methods conveys no suggestion of a deterioration in the derivatives positions of either entity.
4) Disclosure levels are a subjective matter. More is always better. Generally speaking, however, analysts view FNMA's disclosure as better than most of the corporate world.
5) There does not appear to be any evidence of a change in credit insurance policy.
6) Few, if any, companies disclose derivative counterparties (generally, those counterparties object to the idea of other traders getting a sense of their book - it ruins the poker game). FNMA discloses the credit rating of all their counterparties by dollar value. Again, pretty good disclosure.
7) Risk-Based Capital Rules attempt to reduce total risk to a few parameters and are therefore easy to criticize. There are plenty of analysts who feel that FNMA and FRE operate under stricter rules than banks, given the demonstrably lower credit risk in their balance sheet.
There is more to criticize on technical grounds, but I think you get the idea.
So most of Wall Street is busy sending out faxes and research reports demonstrating how factually-challenged the editorial is. The Chairman of FNMA even took the unprecedented step of sending out an open letter to analysts and market makers pointing out the above inaccuracies and criticizing the tone of the editorial (I'd link to it, but it's not on their website for some reason). In fact, while this topic will no doubt be a snoozer in blogdom, the WSJ has enraged thousands of inhabitants of its namesake neighborhood.
I'm with my neighbors. This appears to be every bit as bad as the Times' constant Enronization of everything corporate or Republican.
There are many legitimate reasons to question the advantages that GSEs enjoy in the marketplace, as the Journal does every election season. Congress must debate our implicit support of these enormous market players. This attack, however, was not only unnecessary and ill-formed, but unwelcome in an environment of wobbling investor confidence.
UPDATE: Two news stories describing the Chairman's response:
Reuters
CBS Marketwatch
'NOTHER UPDATE: The editorial uses the phrase "lots of leverage and snarkily hedged risk". How does one hedge "snarkily"? Is there such a thing as an "Acerbic Swap"? Was the usual editor on vacation?
Posted by Mindles H. Dreck at February 21, 2002 8:42 AM | Technorati inbound links"); ?>