Federal Home Loan Mortgage Corporation - Page 42

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               the value of Freddie Mac’s equity is always equal to                   
               the present value of its Asset Spread to Market plus                   
               the value of its Favourable Financing Assets.  Thus, if                
               the present value of the Asset Spread to Market is                     
               negative, the value of the Favourable Financing Assets                 
               will exceed the value of equity.  * * *                                
          In order to illustrate this point, Professor Schaefer used the              
          following example:                                                          
               A more concrete example is provided by the S&L crisis,                 
               which featured negative Asset Spreads to Market, and                   
               therefore Favourable Financing Assets with a higher                    
               value than equity.  In the early 1980s, when interest                  
               rates rose sharply, the condition of many S&Ls                         
               deteriorated as the value of their fixed-rate mortgage                 
               assets fell.  Suppose that, in September 1981 when                     
               mortgage rates were above 15%, an S&L held fixed-rate                  
               mortgages paying a rate of 6% and therefore selling at                 
               around 40% of their face amount.  Suppose further that                 
               this S&L was fortunate in the sense that it was                        
               entirely financed with core deposits * * * that paid 2%                
               and therefore, despite earning 6% on its assets when                   
               market rates were 15%, it nonetheless earned a positive                
               spread of 4% (equal to the rate on its assets of 6%                    
               less 2% paid on its liabilities).                                      
               To the extent that the core deposits remain in place,                  
               this S&L is solvent.  However, its positive net worth                  
               does not come from its assets--these have fallen in                    
               value by 60%--but from its liabilities.  The total                     
               spread of 4% is made up of a substantial and negative                  
               Asset Spread to Market of--9% (a 6% asset return less a                
               15% market rate) and a large and positive Favourable                   
               Financing benefit of 13% (the 15% market rate less the                 
               2% paid on deposits).  The value of the Favourable                     
               Financing Assets for this S&L (the present value of the                
               13% spread) would clearly exceed the value of its                      
               equity (the present value of the 4% spread).                           


               17(...continued)                                                       
               represents the “favourableness” of the firm’s assets,                  
               just as the difference between the market and actual                   
               financing rates represents the “favourableness” of the                 
               firm’s liabilities.  * * *                                             




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