Freddie Mac, the big mortgage finance company, posted a $2 billion loss for the third quarter and warned that it might not have enough capital on hand to cover the mandatory reserves for its mortgage commitments.
...Freddie’s misfortune is particularly rattling because the company is considered something of a backstop for the lending industry.
Over ten years ago, I worked for Freddie Mac. Freddie Mac received its charter from the government, and the charter said that we were to buy "investment-quality loans." When I was there, we took this to mean loans where either the borrower made a down payment of 20 percent or the borrower made a down payment of 10 percent and private mortgage insurance covered another 10 percent in case of default.
In the article, I detect an attempt to spin Freddie Mac as a victim of a "crisis" that was outside of its control. However, somebody should look into whether or not the loans in Freddie Mac's portfolio that are defaulting were truly of investment quality. If instead it turns out that Freddie is suffering from defaults on subprime loans, then my view would be that Freddie's executives are villains, not victims. If any company should have had the institutional memory, know-how, and clarity of mission to avoid buying junk loans, it would be Freddie.
If the politicians want to change Freddie's charter to make it the savior of sub-prime mortgage borrowers, then they may do so. That is part of the political risk that Freddie Mac's shareholders face. (I am no longer a shareholder, except insofar as the stock is included in the S&P 500 index and I own mutual funds that track that index).
But I think there is a lot to be said for sticking to the original charter. From a public policy perspective, I think we are better off with Freddie Mac doing less fishing in subprime waters, not more.
UPDATE: A commenter raises the issue of whether accounting losses exceed actual losses in the current subprime crisis. That is, suppose that only $3 million of default losses are likely to occur on a $50 million pool of subprime loans, but because of loss of confidence, the market price of the pool drops to $40 million. Using mark-to-market accounting, the holders of the pool take a loss of $10 million, not $3 million.
My view is that the holders in fact should record a $10 million loss, and then if they hold the pool they can record a gain in subsequent years. It's much better to take write-downs too much, too soon than too little, too late.