A speech by Fed Governor William Poole GSE Risks, outlines the risks that the GSEs could trigger a financial crisis. While this might be part of the Bush administration’s efforts to reign in Fannie Mae (covered in an excellent Fortune Magazine article this week), it is still surprising that a central banker would be so outspoken on this point — in the speech he uses the word ‘crisis’ ten times. Poole says:
A second reason to understand the risks is that sound public policy decisions depend on such understanding. To reduce the potential for a financial crisis, risks need to be mitigated. Fannie Mae and Freddie Mac face five major sources of business risk: credit risk; prepayment risk; interest-rate risk from mismatched duration of assets and liabilities; liquidity risk; and operational risk. A sixth risk, so-called political risk, arises from the possibility of regulatory or statutory revisions that could adversely affect those who hold the firms’ debt or equity. I’ll discuss these risks in turn, devoting much more time to some than others. Along the way, I will also discuss an extremely important point concerning the frequency of occurrence of large interest-rate changes. This issue is critical to understanding the risks of any strategy involving incomplete hedging.
He goes on to give an excellent summary of the types of risks facing the GSEs. However, there is nothing new here, he is only making a series of points that critics of the GSEs have been making over the last several years.
