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FNM and FRE will cost you a bundle

Saturday, August 23, 2008, 1:37 PM




What Will Mac ’n’ Mae Cost You and Me? (August 23 - NYT)

 The inevitability of a taxpayer-funded bailout
of Freddie Mac and Fannie Mae, the hobbled mortgage behemoths, shook
investors last week, and shares in both companies plummeted on fears
that existing stockholders would be wiped out.

Nobody knows how
the Fannie and Freddie situation will play out. But the implications of
a default on the companies’ subordinated debt shows how complex and
confounding — not to mention costly — this business of bailouts has
become.

The
main reason that FNM and FRE are “too big to fail” is that they are
both far too deep in the derivatives game for anybody to have a
reasonable assurance of what would happen if they did fail. And nobody
wants to find out, because the fear is that such a scenario could
literally wipe out the entire banking system.


Remember, it was
Fannie that announced in 2005 that it couldn’t quite finish reporting
its 2004 results because its derivative portfolio was too tangled to
easily measure. So they set out, and after they unleashed a crack team
of 1,500 forensic accountants and racked up $800 million in expenses,
they proudly announced their final results for 2004 in….2006.

To recap: A single company, using a substantial proportion of the best
accounting talent in the world, after spending a year and a half and
$800,000,000.00, during stable market conditions, was finally able to
provide an accurate assessment of its fiscal condition two years prior.

What would happen if multiple large companies got into trouble during a time of market turbulence? That’s what nobody wants to find out.

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