The Ring of Fire, Part 2

As noted in a previous post, I’ve been slowly wading through the mass of data and analysis presented in “This Time is Different: Eight Centuries of Financial Folly“, by Reinhart and Rogoff.  It’s slow going, but I have to concur with Barron’s review:  this book is a “tour de force of quantitative analysis” and is a primer on the critical nature of the “magic” 90% debt to GDP ratio cited by many as a “point of no return” for sovereign debt risk.

The US currently sits at an “official” 84% debt to GDP ratio and, in accordance with President Obama’s current budget, will exceed 94% this very year.  Also noted, these figures do not take into account the full debt burden of the United States federal government, omitting rather critical and significant obligations such as $6.3 trillion of GSE liabilities for Fannie and Freddie

These account balances have been excluded, traditionally, because of the “quasi-governmental” status of these institutions, the “quasi” part now being obsolete.  So, why are they being excluded now?  Well, for starters, including these liabilities increases our debt by roughly 50% and our debt-to-GDP ratio to more than 130%.

These figures, it should be noted, push the US somewhat deeper into the “ring of fire” than, say, Greece finds itself today.  I guess it is “for the best” that these facts stay hidden from the general public, not to mention the global bond market.

Harry Tuttle


3 responses to “The Ring of Fire, Part 2

  1. Mr. White:

    Well, so far, it appears that nobody seems to know just how much Fannie and Freddie assets are worth – either right now or in the future, The stated liabilities, which are now guaranteed by the US government, is in fact, in the range of $6.3 trillion more or less. Valuation of the underlying assets is a whole ‘nother problem.

    As we know, the value of underlying collateral has declined, perhaps by as much as 25% or more, and may still be declining, depending on which study you follow.

    The share of homeowners with mortgages in negative equity was recently estimated by Zillow at 21%. I’m not sure, but that may be 21% of 100% of homeowners or, alternatively, 21% of the 65% or so with mortgages. So, it’s either something like 8 million or 12.5 million in negative equity at the moment.

    Another take from the Fed: Total residential mortgages were in the range of 55 million or so, of which 7% were delinquent 3.3% were in foreclosure at the end of 2008. These rates were running 2-3X the typical levels exhibited earlier in the decade. The net result was 1.27% in charge-offs, which were 10X higher than earlier in the decade. Not sure where we were in 2009 yet or what the longer term trend is going to be.

    Of course, these data only tangentially impact the underlying security value…i.e. the value of the MBS or the mortgages themselves. Like any bond, the risk and rate of default along with the imputed yield that the market would require would have more dramatic effect on their face values…if they were (or needed to be) sold.

    Another big question in my mind is the comparability between Fannie and Freddie debt (their liabilities) used to fund these mortgages and the mortgages themselves. Are we talking short-term borrowing and longer-term lending? That’s pretty commonplace in the banking world and, often enough, is rationalized by typical refinancing or retirement rates for the mortgages, which are also subject to market forces. (For obvious reasons, there are a lot fewer sales and refi’s going on at the moment.)

    In effect, is there any risk of borrowing costs rising if/when that short-term debt expires? That’s a question that’s completely separate from whether or not the mortgages themselves are delinquent, foreclosed, being charged off, etc.

    Under conditions where: a) higher than normal delinquencies and foreclosures continue, b) charge offs rates continue to climb, and c) short-term debt rolls over at higher rates of interest, it is not outside the realm of possibility that the value of the underlying assets (the MBSs themselves) might easily decline to 50% or less than the liabilities.

    At present, there aren’t any really good answers to these questions, notably due to the fudging going on since the FASB rule changes. The real value of “off-balance-sheet” assets are still a big question mark, whether we’re talking about Fannie or B of A.

    The math, obviously is tricky and subject to a range of error-prone assumptions. So, even if the risk isn’t 100% of the stated liabilities, it could still be more substantial than just the decline in the market value of the collateral. What percent of risk is there? Who knows.

    For the purposes of accounting, which was the point of the post, the CBO currently estimates that the “unsecured corporate debt” held by Fannie and Freddie is in the range of $1.6 trillion and should be added to the national debt totals. What, if any, additional portion of the $4.7 trillion in mortgage liabilities should/will be accrued, is still an open question.

    By the way, the CBO is also currently estimating that operating shortfalls for the GSEs will run about $370 billion over the next ten years and, naturally, should also be added to the federal defecit tabulations.

    Hope that helps.



  2. Mr. White:

    Good question, as usual. I’ll continue to look into it and report back. Offhand, you might be correct, as none of the reporting on the issue specifically states that these are “net” liabilities. Still, the consensus expressed in many of the articles I’ve read seems to be that typical FASB rules should require the inclusion of these liabilities. I have also seen data indicating that current operating shortfalls for these GSE’s are accruing at the rate of several hundred billion dollars per year. As with the “unfunded liabilities” for SS and Medicare, etc., we may be looking at a net present value problem; calculations which, of course, are subject to a wide range of variable assumptions.


  3. harry dexter white


    Regarding this $6.3 trillion in GSE liabilities, is that net of the GSE assets? If not, shouldn’t we include those in our accounting. It seems unlikely that all those mortgages are going to be marked down to zero.


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