As for my accounting question, it was rhetorical. I already know the answer . Guarantees are not on the balance sheet because they are significantly less binding then liabilities, which are the result of a completed transaction, as opposed to a contractual obligation, with all the ambiguities that contract may contain. Accounting does always have reason behind its requirements. We may not always agree with the reason, I certainly don’t, but there always is one. (I disagree with you about faiv value accounting – primarily because there is no appropriate way to come up with an accurate fair value in todays market.)

As for whether FNM & FRE continue to word their purchase contracts in a way that allows them to decide if originators have breached reps and warranties with respect to the quality of the loans and the work the originators do to prove that quality (the underwriting process), I don’t know. I haven’t looked at those purchase documents for many years, but I would be extremely surprised if FRE or FNM would have given up these rights as they are at the core of their guarantee. No company would ever provide such a significant guarantee, for such a paltry fee, without other assurances. FRE & FNM don’t need to use those provisions in normal times. It’s only at the end of a real estate bubble, when the underwriting process breaks down and the quality of loans becomes more questionable, that these provisions become important.

I doubt that is the case anymore. I’ve never heard about what you’re describing. This is one reason so much Alt-A production when into agency pools–easy way to layoff the risk as long as you stick to certain criteria.

As for accounting… It rarely makes sense or has much rhyme or reason. Why can a company make money from it’s credit quality deteriorating? Why is Schwarzman railing against fair value accounting (wrongly, in my view)?

Thanks, though, for the spirited discussion! I appreciate you taking the time to comment and consider the thoughts in the post!

-DJT

Why do you think the accounting treatment is different for guarantees than for liabilities?

I fail to see how reps matter. My recourse to you, as a rep, only kicks in if you lied. For example, if I represent that I have run done something or qualified a borrower in some way, and it turns out I didn’t, then I can hold you liable for damages. However, if all my reps are true, and you own the risk, and the mortgage defaults … Then Fannie or Freddie can’t go back to the originators because they have reps. Indeed the way originators get agency M.B.S. is by selling their mortgages and buying pools… so the risk is transferred in the transaction. Maybe I’m missing something but it seems like you’re comparing apples and oranges.

-DJT

Your essential point is incorrect. There is a big difference between guaranteeing the timely payment of principal and interest and taking on the entire risk of a mortgage defaulting. To get from their words to yours requires, more than a little, greasy wordplay. Perhaps you are not aware that Freddie & Fannie have specific access back to the originators of the mortgage under a number of reps and warranties in the sale contract. Maybe you should try reading that.

your comments about “mission creep” are more on point.

“Now, if regulators understood these products, they would understand that securitizations are structured in a way that Fannie and Freddie could be at risk for a decline in value of their own securities that occurs from the performance of the other assets–the ones that have nothing to do with their goals and charter.”

This is what is known as a counterfactual conditional (only in fantasy land do the regulators understand these products) so perhaps the subjunctive is more appropriate: “Had the regulators understood, if the regulators were to understand” etc etc.