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31 August 2008

Fannie, Freddie and Derivatives Law

It is hard to avoid stories about Fannie Mae and Freddie Mac, the US mortgage institutions, in the press of late but I thought the article "Derivatives law sheds light on the financial ripple effect" in the FT posed an interesting problem about the potential "conservatorship" (or put another way, nationalising these institutions so that they are run and effectively owned by the US govt).

Fannie and Freddie are heavy users of interest rate derivatives ($2.5 trillion notional apparently) and any nationalisation would trigger bankruptcy clauses in interest rate swaps, which would allow the counterparties (mainly banks) to cancel any "in the money" deals adding huge financial claims on top of the existing mortgage/credit problems driving the more towards conservatorship. Seems like the US Treasury has a few more problems to deal with...

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