Investors Ask: What's the Rap on Duration Gap?(time between assets and liabilities)

If anyone really, truly understands what a "duration gap" is and what it really truly means in regard to Fannie Mae and Freddie Mac's financial health, give me a call, I'd like to chat with you.

Depending on who you talk to, Fannie's negative 14-month duration gap at the end of August registered a broad range of responses ranging from a big "so what" to "these guys are ready to get slammed."

When Fannie revealed that its duration gap - which measures the difference, in months, between the duration of its assets and liabilities - was negative 14, its stock got clocked, and anti-Fannie/Freddie forces mobilized to get the word out to a news-hungry media.

But, lo and behold, on Sept. 30, Fannie Mae struck back, announcing to the world that in just 30 days it had reduced that negative measurement to 10 months - a handsome 29% improvement. And on that faithful day, its stock soared 9.5% and the short sellers and FM Watch backers wept.

So what's it all mean? That duration gap, as a measurement of risk doesn't mean much? Yes, I know what a duration gap is - I explained it in the third paragraph. It means that Fannie's assets are repricing on a different timeline than its liabilities, and I guess, that maybe, that's a bad thing. Who knows for sure?

It's interesting to note that Freddie Mac's duration gap is at about zero - and apparently that's a great thing. Confused by all this? Me too, so I went to a well-regarded mortgage expert who I've known and trusted for years and who I know is revered in this industry for his understanding of all things mortgage related.

Requesting his name not be used, he made a few interesting points about the measure known as duration gap: The plus or minus months measurement could be totally meaningless. "You can't tell, based on what they're telling us, what the dollar risk is - what the risk is to net income." Good point.