Do Taxpayers Benefit From Fannie and Freddie Using a Clearing House?

More

Fannie Mae and Freddie Mac will begin using a clearing house to trade their interest-rate swaps by year's end, according to a Wall Street Journal report. The nice thing about trading through a clearing house is that it shields counterparties from losses that would otherwise result if a firm can't cover its derivative obligations. If such potential losses occur, then the other firms who participate in the clearing house pay for what the troubled firm can't. Is this good news for taxpayers? Probably not.

It sure seems like it would be through WSJ's report:

For years, the mortgage firms have purchased the swaps from Wall Street banks to hedge their huge mortgage portfolios against rate swings. The banks, such as Goldman Sachs Group Inc. and J.P. Morgan Chase & Co., make money by structuring the deals and selling them to clients.

With so-called central clearing, banks play a similar role but operate under the umbrella of a clearinghouse that guarantees the trade for both parties in case one side defaults. The guarantee is something that many felt was badly missing during the financial crisis. Then, markets seized up amid fears that some firms would falter and be unable to make good on their swap trades.

The WSJ appears to be indicating that, somehow, Fannie and Freddie will save money now by using a clearing house. The grounds for this assertion are unclear. They will continue to have to pay structuring and placement fees to banks when they create new swaps. In fact, these swaps will likely be more even costly if traded through a clearing house, because Fannie and Freddie will have to put up additional capital in order to use the clearing house.

And the news gets worse. As mentioned earlier, if a firm using a clearing house runs into trouble, then the others who use the trading facility cover any potential losses to counterparties. As a result, the firms who participate in a clearing house won't let just any firm in: they must be very healthy, so that bankruptcy is unlikely.

If you follow Fannie and Freddie, then you know "healthy" isn't a word anyone uses to describe them. The biggest of bailout recipients, they continue to struggle with delinquencies. As a result, any clearing house that lets these trouble firms in must be demanding some level of ongoing support from the government to protect it from a GSE default event. The decision to trade through a clearing house will likely make it harder to wean Fannie and Freddie off government support.

Fannie and Freddie do get something for the higher cost they will pay for trading through a clearing house, however. The credit risk of their derivatives exposure will shrink. Now, if a bank goes under who wrote a swap with Fannie, the clearing house will cover the potential loss.

So is the move overall a good one for taxpayers? It depends on how you weight the cost and benefit. The benefit just explained will ultimately be significant to Fannie and Freddie. But the cost of making it harder to privatize Fannie and Freddie is quite bad for taxpayers. After all, if the GSEs were privatized, then taxpayers wouldn't have to worry about its derivatives exposure anyway.

Jump to comments
Presented by

Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.
Get Today's Top Stories in Your Inbox (preview)

What Crazy Tech Idea Could Become Real?

"There could be great intelligence enhancements, like infinite memory."


Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register. blog comments powered by Disqus

Video

Why Do People Love Times Square?

A filmmaker asks New Yorkers and tourists about the allure of Broadway's iconic plaza

Video

A Time-Lapse of Alaska's Northern Lights

The beauty of aurora borealis, as seen from America's last frontier

Video

What Do You Wish You Learned in College?

Ivy League academics reveal their undergrad regrets

Video

Famous Movies, Reimagined

From Apocalypse Now to The Lord of the Rings, this clever video puts a new spin on Hollywood's greatest hits.

Video

What Is a City?

Cities are like nothing else on Earth.

Writers

Up
Down

More in Business

Just In