In this issue:

Fannie Mae Admits Large Derivatives Losses

Seven Counterparties Hold Three-Fourths of Fannie's Derivatives

Reich Warns Bubbles Popping Could Be Shot 'Heard 'Round the World'

Virginia Joins Other States as It Hits Fiscal Wall

What Recovery? Record-High Bankruptcies in 2003


From Volume 3, Issue Number 12 of Electronic Intelligence Weekly, Published Mar. 23, 2004

U.S. Economic/Financial News

Fannie Mae Admits Large Derivatives Losses

In its annual report filed on March 15, U.S. mortgage giant Fannie Mae said that its losses stemming from derivatives contracts closed during the years 2001-2003, amounted to almost $15 billion. Its reported losses on closed derivatives contracts were $1.7 billion for 2001, $5.8 billion for 2002, and $6.9 billion for 2003. Last week, London's Financial Times presented a study by an independent research institute claiming that Fannie Mae's derivatives losses had been in the range of $24 billion, and were estimated at a little over $15 billion, after taxes.

On March 16, the Financial Times said that Fannie Mae also reported losses on open hedge positions of $5.3 billion for 2003; these can potentially be recouped if held to maturity.

In a filing with the Securities and Exchange Commission (SEC) on the same day, Fannie Mae further announced that due to "volatility in the market last year," its derivatives holdings surged by an incredible 59% (last year) to above $1 trillion. Furthermore, Fannie's short-term debt (coming due within 12 months) increased by 27%, to $484.1 billion, while longer-term debt went up by 1.7%, to $477.1 billion.

In a special report released March 1, the Federal Deposit Insurance Corporation (FDIC), issued a strong warning concerning the exposure of U.S. commercial banks and S&Ls in debt titles issued by Fannie Mae and Freddie Mac, the so-called Government Sponsored Enterprises (GSE). Not only in the case of a liquidity crisis at one of the GSEs, but already as a consequence of a formal withdrawal of their implicit public guarantees, the debt titles issued by Fannie and Freddie could plunge in value, thereby causing massive losses at commercial banks and S&Ls. Total unsecured GSE debt held by FDIC-insured banks and savings associations amounted to $296 billion at the end of the third quarter 2003.

On top of this, the same banks and savings associations held $763 billion of mortgage-backed securities (MBS) issued by Fannie and Freddie. For the average U.S. commercial bank, these holdings add up to 151% of their core capital; in the case of the savings associations, it's 181%. There are actually a number of FDIC-insured institutions which "have very high concentrations of GSE-related securities that amount to more than 500 percent of their TIER 1 Capital." This means that a 20% plunge of Fannie and Freddie debt titles could wipe out the entire core capital of such banks.

Seven Counterparties Hold Three-Fourths of Fannie's Derivatives

Seven counterparties account for 74% of Fannie Mae's trillion-dollar derivatives portfolia, Fannie Mae revealed in its annual 10K filing with the SEC. Fannie Mae has 23 derivatives counterparties, and seven of those institutions, each holding between 6% and 16% of the total, account for 74% of Fannie's $1.04 trillion derivatives portfolio; with the remaining 16 counterparties each holding 5% or less. Those "counterparties consist of large banks, broker-dealers and other financial institutions that have a significant presence in the derivatives market, most of which are based in the United States," Fannie Mae said. The counterparties were not named, but they are likely led by the usual suspects, JP Morgan Chase, Bank of America, and Citigroup, and perhaps investment banks such as Merrill Lynch, Morgan Stanley and Goldman Sachs.

U.S. commercial banks also held $982 billion in mortgage-backed securities at the end of 2003, up from $912 billion at the end of 2002, according to the FDIC's latest quarterly banking profile.

Reich Warns Bubbles Popping Could Be Shot 'Heard 'Round the World'

Interviewed on National Public Radio's Marketplace March 17, Robert Reich warned of the multiple bubbles that will shake the financial world when they pop. Reich, who was Secretary of Labor in the Clinton Administration, told Marketplace that the 2000 crash was due to Greenspan's refusal to raise interest rates to slow down "irrational exuberance." He asked: "Is history about to repeat itself? With interest rates so low, money has been rushing into assets like shares of stocks and real estate." He recounted the biggest market gains in 50 years over the last year, if adjusted for inflation; home prices at the highest levels in 25 years; a consumer bubble, based on consumer debt which is the highest in 20 years, since "consumers borrowed against these soaring values of their homes and stock portfolios. If all these bubbles keep expanding, and then burst, the sound will be heard around the world."

Reich concluded, oddly enough, that the Fed should not raise rates, "until the economy is back on track."

Virginia Joins Other States as It Hits Fiscal Wall

The 2004 Virginia legislative session could adjourn without adopting a new two-year state budget, threatening a government shutdown in July. Media reports are full of the pious statements of Gov. Mark Warner (D), legislative leaders, and experts about the "refusal to compromise" of the House of Delegates—which proposes tax increases of a few hundred million dollars—and the Senate, which wants a $3.9-billion, two-year increase in income and sales taxes. Both houses are Republican-controlled!

Lost in the "refusal to compromise" morality play is the underlying issue: The state Republican Party has fixated on "no new taxes" for several years, while taking control of the legislature, thanks to the similar obsessions of voters, and the passivity of the Democrats—until Moody's and Standard and Poors both, in November 2003, threatened to downgrade the state's credit, due to huge budget holes from falling tax revenue. Virginia, whose semi-annual budget is about $29 billion, has had multi-billion-dollar budget holes open up in its last two budgets, requiring severe cuts against higher education, state layoffs, closure of some state offices, etc. But the budget shortfall has returned: Total state revenues are lower than they were three years ago, due to the economic collapse. Without tax increases, as much as $800 million more in cuts would be needed in this new budget, hitting the bone of economic activity in the state.

Thus, the conversion to tax increases, by the Senate and the Governor (while the House leaders pathetically insist, echoing the President and GOP crowd in Washington, D.C., "No! There's a recovery coming! Don't raise taxes. Just wait!"). In fact, the state is in the vise Lyndon LaRouche has emphasized: cutting economic activity if it does raise taxes; or cutting economic activity and tax revenue by budget austerity, if it doesn't.

The impasse continued as this was being written: The legislature adjourned March 17, was called back into emergency session by Warner the following day, March 18-19; after which there was still no sign of budget. House leaders are now back to demanding a popular referendum on tax increases. Standard and Poors has again announced it is "reexamining" the state's credit rating.

What Recovery? Record-High Bankruptcies in 2003

In another slap in the face to the wishful thinkers promoting the phony "recovery," the American Bankruptcy Institute (ABI) reported March 12 that one of every 73 U.S. households filed for bankruptcy in 2003, a record high, despite interest rates at a 45-year-low. Utah, ABI said, had the highest per-household bankruptcy rate—one in 47—followed closely by Tennessee, Georgia, and Nevada. Household debt had soared to $10.4 trillion, at the end of last year, according to data from the Federal Reserve. There were 1.625 million personal bankruptcies filed in calendar 2003.

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