More data, that is, and more questions.
Freddie Mac, still fixing weaknesses that came to light in 2003, yesterday issued its first timely annual report in five years.
Freddie now has annual reports for 2004, 2005, and 2006 linked from its webpage, correcting an alarming deficiency that I had earlier highlighted. Elsewhere, the San Diego City Employees’ Retirement System also managed to finally get their 2004 annual report up, doubtless also in response to my complaints. I see that when Econbrowser gripes, stuff happens! [Note to SDCERS-- wouldn't it be cool now to get the 2005 and 2006 reports out too?]
Unfortunately, I had a hard time finding the information I was looking for in Freddie Mac’s 2006 report. I did find plenty of broad warnings of the sort that might mollify the lawyers and accountants who were asked to sign on, such as this statement on page 56:
Operational risks are inherent in all of our business activities and can become apparent in various ways, including
accounting or operational errors, business interruptions, fraud, failures of the technology used to support our business
activities and other operational challenges from failed or inadequate internal controls. We face a number of significant
operational risks, including material weaknesses and other significant deficiencies in our internal control over financial
reporting. These operational risks may expose us to financial loss, may delay or interfere with our ability to return to and
sustain timely financial reporting, or may result in other adverse consequences.
That ought to cover it, don’t you think? But what I was unable to find were specific numbers for the dollar magnitudes of Freddie’s total notional exposure from its various derivatives and guarantees, or the circumstances under which those liabilities would show up as negative cash flow. For that matter, I did not see an explanation of the specific factors that turned a $2.3 billion positive entry for “non-interest income” in the first half of 2006 into a $1.4 billion loss for 2006:H2 (page 91). Presumably this had something to do with the positions Freddie had staked out through derivative contracts, but what were these and what macro factors were driving the swings? Lower mortgage rates? Higher default rates? Or are these derivatives and their interaction with the rest of the portfolio so complicated that even people at Freddie Mac aren’t sure of the answer?
I also recently came across this March 5 speech by
James Lockhart, who is the Director of OFHEO, the agency with some oversight responsibility for Freddie and Fannie. Lockhart’s slides include the following very interesting graphic:
These numbers imply that the ratio of residential mortgages to GDP increased 50% over the last 15 years, a trend that may have some good economic explanations though it could not continue indefinitely. But mortgage-backed securities issued by Fannie Mae and Freddie Mac doubled as a fraction of GDP, while the ratio of mortgages retained by the GSEs to GDP quintupled. If the growth in the latter two have indeed been fueled by a perceived implicit government guarantee, that raises the possibility that much of this growth would not be justified by economic fundamentals, but may instead have contributed to a socially undesirable level of systemic financial risk.
How much risk? Maybe we’re about to find out.