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Watch Fannie Mae and Freddie Mac

Editor's note: Following is the first in a series of blog posts by John Hempton, the chief investment officer and founder of Bronte Capital. They originally appeared on Hempton's blog on the Bronte Capital Web site.

The Lack of Analysis in the Public Domain

The discussions about the future of Fannie Mae (FNM) and Freddie Mac (FRE) are taking place in a vacuum, where there are no decent public analyses of the government's contingent liabilities with the two government sponsored enterprises. The main goal of this series will be to remedy that oversight.

I write this series in the face of genuine press and public surprise at the relatively good results of Freddie Mac. I do not mean to sound boastful, but I privately predicted those results quite accurately. This series will explain how I got to that prediction -- and where Fannie and Freddie losses go from here.*

Losses Are Not From Traditional Business

Fannie and Freddie traditionally insure qualifying mortgages. These are mortgages with:
  • loan-to-value ratios of less than 80% (or with supplementary mortgage insurance for higher loan-to-value ratios).
  • principal amounts owing lower than the qualifying mortgage limit (which used to be below $300,000 but has been increased several times during this crisis).
  • income, employment and assets verified.

These mortgages were never very risky and to date have caused very few problems (although Fannie and Freddie are provisioning for enormous problems that will come).

I can demonstrate this.

At the end of 2007, Freddie Mac had $26.7 billion in common stockholders' equity and 14.1 billion in preference shares outstanding -- a total of $41.1 billion in capital.

By the end of the first quarter all of that capital had been wiped out. In addition, Freddie Mac needed a capital injection of $51 billion from the government to maintain positive net worth. More than $91 billion in capital evaporated.

(Fannie Mae shares closed up 7 cents to $1.92, while Freddie Mac shares closed up 21 cents to $2.24.)
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