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Fannie is Trading Derivatives Hard, and Losing
It has been my contention that the Agencies were a factor in the bond
market volatility in the past three months. Fannies 10Q has the
following information regarding their derivative activity in the first
six months of the year. As of June 30 FNM had a balance sheet of $900
billion. Against that position they bought and sold over the counter
derivative contracts totaling $1.2 Trillion. On average $100 billion
per day. There can be little doubt but that FNM has been adding to the
volatility in the credit market.
As luck would have it, the end result of all of this was a loss of $2.2billion.
Who
was the other side of these contracts? These big amounts require big
Houses to price them. So this activity is done by just a handful of
market makers. FNM had 22 days where they lost $100 mm. One can only
wonder who was on the other side of those $100mm days.
Of
interest is that FNM had to put up $13.5 billion of cash collateral to
support outstanding derivative contracts. Wall Street will not ‘take
their name’ any longer. This cash collateral requirement is similar to
AIG. In that case the bulk of the cash went to GS. It is a decent guess
that GS is sitting on a bunch of this $13.5b as well.
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You are surprised that a mortgage fund loses money on hedging? To greatly oversimplify, mortgages are, in general, negatively convex, meaning that you have to buy duration when the market rallies, and sell when the market sells off. Read that again. Buy high, sell low. It sucks, but that's what you have to do to stay hedged. Otherwise, you get summer of 2003 all over again. And look at what rates did at the end of the first quarter....
This could be the new AIG, the CEO could be making losing trades with his friends in other firms since they know FNM is going down - they could try the same bailout trick if it fails completely, but they are probably using it as a conduit for as long as possible as a going concern with uncle sam backstopping (bailouts for 3rd party credit risk will be politically difficult).
My thoughts exactly!
This is insanity for a GSE. There's no reason for this at all since we know interest rates arent' going anyware until the new year.
These are hedges. They pay on swaps to protect their long mtg position. There should be a gain somewhere to offset the losses. It may not be a perfect offset, but it should be close.
Why?? What are they trying to accomplish?
Is this loss Realized, Unrealized, or both? Where is the Conservator?
Is comparable data available for Freddie?
Unbelievable!
"Why?? What are they trying to accomplish?"
i suspect they're trying to hedge interest rate risk.
and that could get really dicey with Ben in the process of cornering treasuries and the subsequent bond market reactions to that. it really sucks to be anyone trying hedge interest rate risk right now. fannies traditional strategies would be obslete in this environment.
Exactly. Try heding interest rate risk in this environment. Then try throwing prepayment risk into the mix, when the rules on eligible prepayments changes by government dictate. Nightmare.
This trading is hedging activity,right? Don't tell me they have a trading desk and are just trying to make a buck speculating. If so I think maybe they ought to stop it.
I think your math might be off on total daily trades for the quarter. In the first diagram you attached they added $153B of swaps and unwound $100B. I would assume that would mean total trades are $253B for the quarter. For easy math let's assume that there were 50 trading days, that equals ~$5B of trades per day, far less than the $100B you stated.