A recent flurry of large losses by some Ohio municipalities dealing in mortgage-backed security derivatives has Fannie Mae and Freddie Mac anxiously awaiting the publishing of new investor guidelines that the GSEs hope will better educate small investors on the risks associated with those instruments.

The new guidelines, created by the Public Securities Association in conjunction with Fannie Mae, Freddie Mac, Farm Credit System, Federal Home Loan Bank System, Federal Agriculture Mortgage Corp. and the Student Loan Marketing Association, call for a greater, more timely distribution of investment details and documents to help investors better understand what they are buying. The guides take effect Jan. 15, and PSA member adherence is free.

The Ohio flap arose recently when several municipalities discovered after audits that they had lost millions in Fannie Mae-backed interest-only strips, a derivative of mortgage-backed securities. Some believe the losses exceed $10 million and, as a result, the state's attorney general has declared Fannie-backed MBSs as unsuitable investments for operating funds of many municipalities and school districts. The Ohio state auditor has called for a ban of IOs for state investments and some analysts predict that more states will also report large losses and may follow up with additional bans.

Fannie Mae and Freddie Mac bear none of the blame in these cases. The GSEs, after all, back securities in the case of default, not interest-rate risk. But as losses mount, it brings to question what Fannie and Freddie ar,e doing to warn smaller, less-sophisticated investors about the dangers of the MBS derivatives they back.

"We are, and have been, long-time advocates of full disclosure," said David Jeffers, legislative counsel at Fannie Mae, who cited the agencys long-standing policy of requiring its dealers to provide complete documentation to investors on the securities they purchase.

Fannie said it went well beyond the PSA guidelines and the agency has taken an active role in educating investors, including an interactive software program that provides a walk-through of a Remic transaction, several brochures, on-line computer services and conferences. Freddie Mac cited similar programs.

"We maintain a separate department for investor inquiries on derivatives and other mortgage-backed securities," said Douglas Robinson. a Freddie Mac spokesman.

"If any investor calls us for information on our securities - including collateral details and data on various prepayment assumptions - we have it available." Robinson said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.