GSEs Reported Losses Mean They Are Not the White Knight Some Had Hoped

Some of the financial world may be hoping that Freddie Mac and Fannie Mae are at least part of the solution to the sub prime mess, but the two government sponsored enterprises (GSEs) seem to have a propensity for getting into plenty of trouble on their own.

Late last week Fannie Mae was hit with a big sell-off as rumors spread that the company's losses from bad loans might be even worse than it had admitted. The rumors related to a change in the way the GSE calculates its credit loss ratio measuring bad loan losses as a percentage of the company's loan holdings. The new calculations create a lower credit loss ratio and led to reports that Fannie was masking its losses.

Then on Tuesday the small GSE, Freddie Mac, announced that its third-quarter losses were more than twice what had been expected and the company said it might have to cut its $2.00 annual dividend in half.

The corporation announced it would suffer a $2.03 billion loss for the third quarter and said it has been forced to sell mortgages and is hoping to raise as much as $5 billion in capital through an upcoming sale of preferred stock. The loss represents $3.29 per diluted common share. In the same period in 2006 the company reported a net loss of $715 million or $1.17 per share. The company also reported a decrease in the fair value of net assets attributable to common stockholders of approximately $8.1 billion for the third quarter compared to an increase of approximately $300 million in 2006.

"Without doubt, 2007 has been an extremely difficult year for the country's housing and credit markets and, as our third quarter financial results reflect, we have been impacted by the deterioration in these markets," said Richard F. Syron, Freddie Mac chairman and chief executive officer. "We recognized the challenges facing the mortgage markets, however, and have taken further steps to address them. At the same time, as our charter mandates, we have continued to meet our mission by playing a stabilizing role in the markets and supporting our customers.

Two weeks ago Freddie's sister GSE, Fannie Mae, announced a $1.4 billion loss for the third quarter.

Following the announcement of Freddie's losses the stock lost 29 percent of its value, dropping to $26.74 by the closing bell. Fannie Mae was also hit, losing one quarter of its value and ending the day at $28.25. Tuesday's losses came on the heels of drops of around $3.50 per share for each of the stocks as several analysts downgraded their expectations for the stocks. On Wednesday the Freddie Mac's stock continue to decline, losing another 0.75 by mid-afternoon but Fannie Mae stock had recovered nearly $1 of its Tuesday losses.

Freddie estimated that its losses from defaults on mortgages it holds on single-family homes could grow to $1.5 billion next year and $2.1 billion in 2009 from an estimated $493 million this year. According to the Wall Street Journal, this assumption is predicated on a decline of 5 percent in home prices where some analysts have predicted that home prices might drop as much as 15 percent in some markets.

Then James Lockhart, director of the Office of Federal Housing Enterprise Oversight which regulates Fannie and Freddie told CNBC television that the two GSEs should hold on to the billions of dollars of capital they use to protect against losses. In other words, the chance that the GSEs could step up and purchase more loans for its own portfolios - a move being pushed by some in Congress but opposed by the Administration - just went from slim to none.

Countrywide Financial Corporation was also and again the subject of speculation on Tuesday to the point that the largest mortgage lender in the country had to issue a statement denying that it might be nearing bankruptcy and saying that it has "ample liquidity."