Perfect Information
If you want an exemplar of the difference between theory and practice and the financial markets, consider what Alan Abelson writes in his Barron's column (behind the paywall) this week:
[T]he roof fell in on housing and the curtain began to come down on the jolly times for Freddie and Fannie. Today, they own or guarantee 45% of all U.S. mortgages, or a cool, $4.8 trillion worth. Looking at their balance sheets, Porter [Stansberry] points out, you find mortgages
with a face value of $1.7 trillion, supported by assets of about $70 billion in core capital. On a combined basis, they're leveraged 24-to-1, but when you toss in their off-balance sheet guarantees, that figure balloons to 68-to-1.
Since the stock market is a perfect-information market, every buyer and seller of FRE and FNM knew not only that the leverage ratio was 24-to-1, but also knew the footnotes to the annual reports well enough to understand the 68-to-1 ratios including the guarantees. And they knew that if, say, those mortgages were worth 95% of their stated value that Fannie and Freddie would have no equity left, even if their guarantees were never called.
Labels: Fannie Mae, Freddie Mac, Perfect information, stupid financial tricks
