CFC Rocked By $140 Million Derivatives Loss

Countrywide Financial provided some detail into the lackluster final quarter of 2004. "Countrywide, however, failed to foresee a situation in which the Federal Reserve raises short-term rates but long-term rates fall -- an event Wall Street terms a flattening of the yield curve. The company blamed $140 million of earnings reduction on a decline in the value of derivatives apparently pegged to short end of the yield curve", The Street.com reported.

This situation reveals a key weakness in the hedge strategy employed by CFC and Fannie Mae. Hedging for interest rate changes is a complicated, high risk tactic given the size of the portfolios. Despite five previous increases in the short term Fed funds rate, the Treasury bond market has not followed suit. The 10 year bond rate is largely what moves mortgage rates.