The markets did their best to treat Freddie Mac as an isolated incident yesterday. It isn't. Freddie Mac is just the latest turn in the expanding spiral of trouble for financial markets, one that won't go away just because investors stuck their heads in the sand for a day.
Freddie Mac is a publicly traded company created by U.S. Congress to provide funds to mortgage lenders. It does so by buying existing mortgages from these lenders and repackaging them to investors as mortgage-backed securities, guaranteed by Freddie Mac itself. In the current environment, that's the business equivalent of playing road hockey on a freeway.
Freddie Mac yesterday reported that it lost $2-billion (U.S.) in the third quarter, took a $1.2-billion provision for credit losses and absorbed $3.6-billion in mark-to-market losses. Now it is threatening to cut its dividend in half and is seeking other sources of financing, just to keep its capital levels above mandated minimums.
The news sent shares of Freddie Mac and its larger government-created mortgage cousin, Fannie Mae, off a cliff. Freddie opened down 33 per cent, Fannie down 23 per cent, and they stayed around there all day.
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