Enron Provokes Little Change in Hedging
Fernandez, Tommy, American Banker
Despite bad publicity and widespread expressions of anxiety about derivatives, mortgage firms have virtually no alternative for hedging the rate risk on their loan and servicing portfolios, many industry players say.
Over the past few months some of the industry's biggest companies -- including Fannie Mae, Freddie Mac, Washington Mutual Inc., and Countrywide Credit Industries Inc. -- have felt pressure to rely less on derivatives or at least disclose more about how they use them.
"Some of the largest, most established and respected companies in America are dealing with an unprecedented level of scrutiny and skepticism," said Franklin D. Raines, Fannie's chairman and chief executive, in a speech Tuesday at the Minnesota Meeting, a gathering of midwestern finance executives. "Normal business terms and strategies like 'hedging,' 'derivatives,' and 'debt' are raising eyebrows, and people want to know more about what they mean."
A derivative is a financial contract in which the parties agree to make payments based on the value or changes in value of various other financial assets -- usually various types of bonds or stocks.
Countrywide and Washington Mutual agreed this year to provide more information about their derivatives transactions. Fannie and Freddie again became targets for politicians, regulators, and conservative editorial page writers; critics of the government-sponsored enterprises have seized on the Enron mess to challenge their activities.
Yet all industry players contacted for this article said that though derivatives are not perfect, the concern about them been overblown. And besides, they say, no other hedge exists.
"Lenders don't have a choice," said one industry observer who requested anonymity. The idea of abandoning derivatives is "outrageous" and the bad publicity is unfair, he said. "Are you going to change the way you run your business just because some people might not understand it?" he asked.
In fact, many observers argue, derivatives are safe and sound if used in simple, careful strategies.
"To me the actual use of derivatives of these companies is not the issue," said Vincent Daniel, an equity analyst at Keefe, Bruyette & Woods. "It is part of their business. The issue is how much derivatives are needed to fund their business, and the cost of those derivatives."
Thomas P. Vartanian, the chairman of the financial institutions and electronic commerce transactions groups at the Washington law firm of Fried Frank Harris Shriver & Jacobson, said the public spotlight on derivatives has alarmed the directors of financial firms.
As a result, Mr. Vartanian said, many financial firms are going through a "self-evaluation process." Many directors are asking how accounting decisions are made and whether they are solid and properly disclosed, he said.
"All the committees on the boards ... are asking questions," he said. "They would have to be from another planet not to ask these questions."
"Boards have to make sure they are not captive to management -- that they don't become too suspicious and gun-shy," Mr. Vartanian said. "Achieving that balance in this environment is very difficult."
Robert N. Husted, a principal at the New York-based MIAC Analytics LLC, said mortgage companies started moving to simplify hedging strategies before the Enron debacle. …