Don't Tar Us With an Enron Brush
Shame on you. The Wall Street Journal, of all publications, has the opportunity and responsibility to provide leadership and shed light on the Enron debacle. At the very least, markets jittery about Enron need calm, trustworthy, responsible voices to clarify complex issues, get the facts, get them right, and put them in the proper context.
Unfortunately, in your Feb. 20 editorial about Fannie Mae, you only fan fears with your glib, disingenuous, contorted, even irresponsible attempt to tar our company with the Enron brush. At best, the editorial betrays a complete lack of knowledge or understanding about our business. At worst, you chose the thrill of a good smear job over the hard work of reporting or writing opinion pieces grounded in facts.
After asking whether readers are "shaking in your boots yet," the editorial claims "we don't want to scare readers here." The editorial page is trying to have it both ways. The innocent victims are the capital markets, the holders of our stock and bonds, and homebuyers. For two years they have suffered the financial consequences of "headline" risk created by the Journal.
Leverage and capital. Your editorial suggests that leverage is inherently dangerous when in fact most mortgages are held by leveraged investors. The real issue is whether the institution holds capital appropriate to the risk of the assets it holds. You fail to mention that Fannie Mae and Freddie Mac are the only large financial institutions in America that operate under a risk-based capital rule with a stress test, meaning we always have to hold enough capital to survive an economic "nuclear winter." Indeed, our capital standard is regarded by some as downright draconian. Former FDIC Chairman William Seidman said it "could be devastatingly stringent if applied to most other financial institutions." The editorial also fails to note that -- in sharp contrast with Enron -- Fannie Mae manages only one asset, in one country -- U.S. residential mortgages -- and it is among the safest, best collateralized assets in the world.
Debt. Debt is crucial to free market and private enterprise. Consumers use debt to finance cars. Private companies issue corporate paper to finance their operations. Americans take out mortgages to become homeowners. The nation's largest banks have billions, even trillions of dollars in debt, much of it government guaranteed deposits. Beyond overstating Fannie Mae and Freddie Mac's debt by more than $1 trillion and misstating that our debt is government-backed (it explicitly is not), your editorial somehow suggests that companies that issue debt are a problem. Fannie Mae's debt finances homes for millions of families. That makes it some of the most secure private debt in the world.
Auditors. In your editorial, you quip, "Their financial statements are audited, for whatever that's worth." What is that supposed to mean? That all auditing is a sham? (The editorial also misstates that we paid $6.6 million in consulting fees to our auditor; in fact, 85% of that was for tax services, and validation fees related to issuing REMIC and other securities.)
Transparency. Good information is the lifeblood of efficient markets; bad information disrupts markets. Moody's calls the financial disclosures Fannie Mae adopted in October 2000 "a new standard . . . for the global financial marketplace could usher in a wave of enhanced financial risk disclosure." You call our financial disclosures "terrible." Who to believe? Consider that your editorial, in addition to overstating the amount of our debt, also grossly overstated our leverage; stated that we cut back on our credit insurance (wrong); grossly mischaracterized the effect of the new Federal Accounting Standard 133 on our shareholder equity when our regulatory capital rose by $4.3 billion; and suggested that congressional hearings were overdue when we had 11 in the past two years. All of the information was available in our monthly, quarterly and annual financial disclosures, on our Web site.
Derivatives. Your editorial mentions in ominous tones Fannie Mae's use of financial tools known popularly as derivatives. But for our business, derivatives reduce risk. Fannie Mae uses the most straightforward types of options, swaptions, caps and floors. We do not speculate in derivatives or engage in derivative trading. We use derivatives to hedge and reduce interest rate risk. We go to great lengths to ensure our derivative counterparties are highly rated, and our derivative contracts are well collateralized. Your focus on the notional amount of derivative contracts was sensational at best. If all our derivative counterparties failed to perform, it would cost Fannie Mae about two weeks of earnings.
Risk. Your editorial rings alarm bells about risk. Risk is a necessary part of daily life and central to the creation of wealth and prosperity. Instead of helping to understand the risk question you chose to be "shocked" that Fannie Mae's business involves the management of credit and interest rate risk. Meanwhile you failed to explain our successes in doing so over many years or that we have posted double-digit operating earnings growth 15 years in a row through all interest rate and economic scenarios.
There are many lessons to be learned from the Enron debacle. One is the importance of careful fundamental analysis of major companies. Fannie Mae welcomes and, indeed, we seek out, that type of analysis.
Another lesson from Enron is that corporate behavior is fundamentally a product of the culture of the company. At Fannie Mae we take pride in the tone we set at the top, in our risk management focus, in our commitment to integrity and intellectual honesty and in the values of our people.
We are well aware that you disapprove of our public mission to direct additional capital to the housing market. Rather than hide behind a fog of accusations about riskiness, why not come right out and debate whether we have too much invested in housing and homeownership in America?
Franklin D. Raines
Chairman and CEO
Fannie Mae
Washington
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Although not residential this also was in today's WSJ...
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Commercial Real Estate
May Damp the Economy
Just when it looked like commercial real estate might slide through the economic downturn unscathed, troubles are brewing.
Managers of new luxury-apartment complexes are offering free rent to entice potential tenants. The vacancy rate for office space, which ended last year at 13.6%, up from 7.9% at the end of 2000, is expected to keep rising. The real-estate practice at law firm Weil, Gotshal & Manges is spending about 25% of its time restructuring distressed real estate, compared with less than 10% one year ago. "It's going to get much, much worse," predicts J. Philip Rosen, the partner who heads that practice.
Then there's Kmart Corp., which filed for bankruptcy-law protection last month. Following the lead of other troubled retailers, Kmart is expected to ask the bankruptcy court to terminate leases on hundreds of store locations, a move that will save Kmart money but will sharply increase the number of empty suburban storefronts.
For the broader U.S. economy, these are troubling trends. Although many forecasters believe the recession is likely over, a small group worries that real-estate woes could slow down economic growth.
"We haven't seen the bottom," warns John Lutzius, analyst at Green Street Advisors, a Newport Beach, Calif., real-estate stock research firm. "Quite a lot of jobs were lost in the last quarter of 2001, and that may not be reflected yet in the vacancy and rent statistics."
There are two main ways that real-estate problems could restrain growth. A sharp and prolonged rise in vacancies could hurt construction, producing tens of thousands of additional layoffs. Also, a mountain of bad real-estate loans could weaken banking, already hammered by Enron Corp.'s bankruptcy, turmoil in Argentina and bad telecommunications loans.
A decade ago, a troubled real-estate sector actually led the nation into recession; billions of dollars of bad loans made to office-building developers led to bank failures and crimped new lending. Credit problems in the real-estate industry this time are much less severe. Equity levels are higher, and lower interest rates are making up for lost rental revenue for the many properties that have floating-rate debt. Standard & Poor's, which tracks $108 billion in rated commercial loans, says the delinquency rate was 2% at the end of January, up from 1.21% at the end of the third quarter of 2001. That's a far cry from the early 1990s, when bad loans amounted to more than 7% of the total.
But chances are growing that real-estate problems could spill over into the broader economy. S&P projects the delinquency rate will be between 3% and 4% by the end of the year. Likewise, commercial construction is slowing dramatically. About $65 billion of work is expected to start in 2002, compared with $81 billion in 2000, the peak year of the last cycle, according to F.W. Dodge, a building-research division of McGraw-Hill Cos.
One reason the industry's troubles aren't as bad as they were in the early 1990s is that builders haven't overbuilt. Instead, the problems come from a less problematic source: a precipitous drop in demand, which is measured by the industry as "absorption." If office tenants, for example, occupy five million more square feet at the end of a year than the beginning, then absorption is "positive five million."
Last year, the office-building sector saw 117.8 million square feet in negative absorption, as failing and contracting businesses gave up massive amounts of space, according to Reis Inc., a real-estate research firm tracking the country's top 80 markets. That's the first time since Reis began tracking the market in 1980 that there was a year with negative absorption. Between 1995 and 2000, the office market averaged an annual 88.1 million square feet in positive absorption, Reis says.
This huge amount of negative absorption is another sign that white-collar jobs have been hit particularly hard in this recession, experts say. Also, numerous businesses -- especially technology companies betting on continued growth -- leased much more space than they needed during the late 1990s. "It's the rubber-band effect," says Lloyd Lynford, Reis's president. "Now it's snapping back."
Demand-side problems typically don't cause as much immediate havoc in the broader economy as does an oversupply of new buildings. Many real-estate owners, especially of office property, are cushioned from rising vacancy by leases that require tenants to pay rent even if they contract. Many landlords also wisely protected themselves from failing tech companies by insisting on large letters of credit as security with leases.
With many landlords and their creditors insulated for now from foreclosures and bankruptcies, some economists believe that worries about real estate are overblown. But the problems also can't be ignored. After all, it's only a matter of time before those letters of credit expire.
"To be cavalier about this would be a mistake," says Peter Kozel, director of commercial real-estate research for S&P. "The industry isn't really dealing with a vacancy rate that's nearing 15% now because a lot of that is sublet space that's generating income for the owner. We have to start having some absorption of space by the end of the year, or we're going to have to start dealing with that 15% vacancy rate." |
