Fannie, Freddie may cause big ($62 Trillion) credit headache

[UpInArms]

Source: Reuters

NEW YORK (Reuters) - An argument is emerging over Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) credit derivatives contracts, and the losers could end up facing billions of dollars of unexpected losses.

Participants in the $62 trillion credit derivative market held conference calls on Friday to discuss a thorny question for credit derivatives: what debt can be used to settle the contracts. The International Swaps and Derivatives Association (ISDA), a trade group, said it plans to offer guidance on the matter shortly.

Settling credit default swaps may seem like an abstruse matter, but billions are at stake. Any previously unexpected losses that participants suffer could be a tough blow to financial markets already rattled by the U.S. government's rescue of Fannie and Freddie.

Investors, banks, and others use credit derivatives to insure their exposure to a company's bonds and loans, or bet on an issuer's credit quality. When a company defaults, derivatives buyers receive a payout, and deliver the company's bonds or their cash equivalents to sellers of the protection.

At issue with Fannie and Freddie are the type of securities that buyers can deliver when they receive their payout. Buyers usually want to deliver the cheapest possible security, to maximize their return from the credit protection.

Some credit protection buyers are looking to deliver "principal only" obligations for their Freddie and Fannie securities, which can be worth around 30 cents on the dollar, compared with regular bonds from the two companies, which are worth closer to 100 cents on the dollar.

Read more: http://www.reuters.com/article/bondsNews/idUSN1257757720080912

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Ruh-roh!

[rusty_parts2001]

1. How about the crummy stockholders who have lost everything.

Shares were trading in the $50.00 range, now worth .50. Ugh!!

[Lucky Luciano]

5. Shareholders bear more of the risk

than bondholders....the FNM and FRE rescue was all about the bondholders...shareholders are the lowest in the capital structure. That is the risk they take to earn greater rewards in times of plenty when corporate earnings are good.

Look up the concept of Enterprise Value...look at FNM and FRE's Enterprise Value...you will see that the shareholders were always a tiny fraction of the entire enterprise. FNM and FRE were highly leveraged companies.

Separately...

The conservatorship of FNM and FRE did cause a technical default for holders of CDS contracts. The question is what the recovery value of the default should be. It should be damn close to par given that the government is backstopping the debt, but some are talking about a 95% recovery being assigned to the CDS contracts (this is done through some kind of auctioning process that is not perfectly clear to me - I am sure it can be googled). So, if there is about $5T notional outstanding and those who sold insurance are on the hook for the 5% difference between recovery and par, then...well....ruh-roh is right....of course a lot of those contracts will offset in that one could own one contract and be short another, in which case one would pay out 5% for the contract they are short and receive 5% for the contract they are long (if the counterparty does not default! Hello Lehman! Hello AIG! Hello MBIA! Hello ABK! Hello WaMu! what a fuggin mess), so the true liability is not clear.

[mike_c]

2. damned parasites....

Those folks produce little or nothing of real value, yet they are a sucking black hole draining society of its wealth.

[mrJJ]

3. The GOP screwed America

Gramm-Leach-Bliley Financial Services Modernization Act.

53 Republican Senators plus one Democrat - AYE

44 Democrats no Republicans - NAY

The Gramm-Leach-Bliley Act, also known as the Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (November 12, 1999), is an Act of the United States Congress which repealed the Glass-Steagall Act, opening up competition among banks, securities companies and insurance companies. The Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services.

The Gramm-Leach-Bliley Act (GLBA) allowed commercial and investment banks to consolidate. For example, Citibank merged with Travelers Group, an insurance company, and in 1998 formed the conglomerate Citigroup, a corporation combining banking and insurance underwriting services. Other major mergers in the financial sector had already taken place such as the Smith-Barney, Shearson, Primerica and Travelers Insurance Corporation combination in the mid-1990s. This combination, announced in 1993 and finalized in 1994, would have violated the Glass-Steagall Act and the Bank Holding Acts by combining insurance and securities companies, if not for a temporary waiver process <1>. The law was passed to legalize these mergers on a permanent basis. Historically, the combined industry has been known as the financial services industry.
..
Economist Robert Kuttner has criticized the repeal of the Glass-Steagall Act as contributing to the 2007 subprime mortgage financial crisis.<6> Economists Robert Ekelund and Mark Thornton have made similar criticisms, arguing that while "in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance" the Financial Services Modernization Act would have made "perfect sense" as a legitimate act of deregulation, under the present fiat monetary system it "amounts to corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly".

"John McCain voted FOR the bank laws that led to the current credit crisis. John Mccain's economic advisor WROTE the law. 53 Republicans voted YES to the law. When you're in danger of losing your house, can you take a chance on more of the same from those who wrecked out economy?"

[davidwparker]

4. What this is is GOP-sponsored theft. Pure. And. Simple.

[central scrutinizer]

6. $62 FUCKING TRILLION, with a Fucking T?????

Tell me again why we should de-regulate these fucking assholes?

[daleo]

7. What's 62 trillion dollars between friends

Now, if we were talking 62 quadrillion dollars...