FHFA's DeMarco on the FHLB's - Ugly

The FHFA’s acting director Edward DeMarco has proven to be a refreshing change from his predecessor James Lockhart. Mr. DeMarco has consistently delivered the straight story ever since he assumed responsibility. Yesterday was no exception.

He spoke at the Directors of the FHLB conference. He delivered this message:

FHFA is looking for the FHLBanks to prepare for eventually moving derivatives activity to central clearing. This is a prudential matter, and one we anticipate the FHLBanks doing with or without legislation mandating it.
The time to be evaluating options in this area is now.

I could imaging the groans of the Directors when this message was delivered. What an elegant way of saying, “Mark you books down now boys, we can’t extend and pretend any longer”.

It is impossible to determine what the size of the losses the FHLB’s are looking at. Here is a look at the trillion-dollar balance sheet:

There may be some losses in the retained mortgage portfolio but I am assuming this is small beer. The $631b of “advances” is probably okay as well. These are short-term loans to Community Banks. These are the banks that show up on the list every Friday from the FDIC. If there is an issue here there is going to be a big problem.

The real concern is in the $284b of “investments”. This is all private label MBS. If the assets are marked to market the losses will be significant. 30-50% is possible. That would put the loss in the range of $80-$120 billion.

DeMarco's words on the “investments”:

“As we all know, when the credit characteristics of those investments changed, leading to losses on the FHLBanks’ holdings of private label mortgage-backed securities, the “normal” operations of some of the Banks were disrupted.”

That is a polite way of saying that they took a bath. Fannie and Freddie will cost us at least $400 billion. Add in another $100b for the FHLBs.