Housing Bubble
Poole - Fannie, Freddie problems could cause crisis in U.S. financial markets
March 10 , 2003
William Poole, President, Federal Reserve Bank of St. Louis, said yesterday that problems with US home finance companies could result in a crisis for the US financial markets.
His speech, 'Housing in the Macroeconomy' at the Office of Federal Housing Enterprise Oversight Symposium was intended to provide an overview of longer-run trends in housing and housing finance but unnerved the markets resulting in heavy selling of Fannie Mae and Freddie Mac.
Citing an earlier OFHEO report on Systemic Risk, he focussed on nonquantifiable risks since "my sense is that the firms are vulnerable to nonquantifiable risks because their capital positions are so low". Furthermore, " major unforeseen events that can bring about a collapse in confidence or disruption to the normal function of financial markets without any warning can and do occur with some frequency".
He outlined the importance of Fannie Mae and Freddie Mac to the economy - "should either firm be rocked by a mistake or by an unforecastable shock, in the absence of robust contingency arrangements the result could be a crisis in US financial markets that would inflict considerable damage on the housing industry and the US economy".
Poole believes that "no one should underestimate the potential importance of the ambiguity over the financial status of the GSEs." and described how contagion would affect others should one experience problems. "If one GSE comes under a cloud, others may also. That has been our experience with financial firms again and again"
Should such a situation arise then "the enormous scale of their liabilities could create a massive problem in the credit markets. If the market value of GSE debt were to fall sharply, because of ambiguity about the financial soundness of GSEs and about the willingness of the federal government to backstop the debt, what would happen? I do not know, and neither does anyone else".
Poole proposed that "the only way for financial institutions to insure stability in the event of nonquantifiable shocks is for them to maintain a substantial extra capital cushion above that deemed necessary by analysis of quantifiable risks. Dismissing the risks of nonquantifiable events on the grounds that they are too improbable to worry about is not a wise approach to public policy".
Source: Housing in the Macroeconomy
