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Roundup: Fannie & Freddie Bailout

Saturday, September 06, 2008 | 06:57 AM

Last evening, we asked what are the costs and consequences, as well as the market reaction to, the imminent bailout of Fannie Mae (FNM) and Freddie Mac (FRE). Your responses were inspired and informative. (For a brief history of the GSEs, see this earlier commentary).

This morning, its page one news. Here's what the major papers are suggesting is the likely outcome:

• Conservatorship: Fannie Mae and Freddie Mac will be brought under government control; The assumption is this is a temporary measure (12-24 months);

• Management: will be kicked out, starting with Fannie Mae CEO Daniel Mudd as well as Freddie Mac CEO Richard Syron. (No word if Charlie Gasparino is defending the two on CNBC). The current Board of Directors would also be fired;no word on other senior management;

• Shareholders: Speculation is that most (but not all) of the common stock would be diluted but not wiped out; Company debt and preferred shares are likely to be protected according to the Washington Post. A variation comes The New York Times, which stated that both the common and the $36 billion of outstanding preferreds "would be reduced to little or nothing."

In a typical recapitalization, preferreds, which are equity, receive little if anything.

• Mortgages: held by FNM/FRE would be guaranteed by taxpayers. This is approximately $5+ trillion dollars, the vast majority of which are sound. (Remember, Fannie was not allowed to buy subn-prime). If 3% of these go bad -- a historically high estimate -- that would amount to ~$150 billion dollars;

• Legislation: President Bush signed the law that gave the government the authority to inject billions of dollars into the companies through investments or loans. At the time, Treasury Secretary Hank Paulson said there were no plans to actually use the money, it was to help the firms raise capital.

• Foreign Holders: NYT: "With foreign governments increasingly skittish about holding billions of dollars in securities issued by the companies, no sign that their losses will abate any time soon, and the inability of the companies to raise new capital" forced the government's hand;

Foreign central banks are key investors in Fannie and Freddie paper, and they have been losing confidence in the GSEs. Barron's reports that "Fed data offer circumstantial evidence of, if not of a run, then of a steady walking away from Fannie and Freddie securities."

• Financial sector: With losses of about $500 Billion, and quite a few billion more to go, the hope is that the relief to FNM/FRE eventually finds its way to the entire sector.

Note that the Preferreds of both companies are primarily banks, many of which already are already suffering from the effects of the credit crunch and mortgage debacle. A bailout of the Preferreds would amount to a $36 billion bailout of the entire financial sector.

• Politics: With both conventions now over (were the GSEs even mentioned?) the Presidential election starts to heat up. The closer we came to November 4th, the greater the risk of political complications. Hence, the bailout sooner rather than later;

• Timing: Any Decision is likely to be announced Sunday, before Asian markets open. Some are speculating that this is an attempt to get out in front, rather than waiting for a "financial tipping point, as happened with Bear Stearns;" Delaying a rescue might also increase the "risks and costs."

• Insolvency: Armando Falcon Jr., who from 1999 to 2005 headed the agency that oversaw the companies' financial stability, believes the GSEs are already insolvent. "I would force the more accurate accounting of their assets and liabilities, and that would show them to be insolvent," Falcon said in an interview. He added that additional delay to receivership "only digs taxpayers into a deeper hole."

One more note: Anytime the government obtains authority to do something -- go to war, spend money on bailouts -- it is identical to actually authorizing the act. Meaning that yes, it will eventually occur. Claiming you are merely granting authority only serves to make the act more politically palatable, but don't ever kid yourself -- it is no different than the actual act.

In practice, the act of authorizing a fill in the blank (war, bailout, whatever) is the same as declaring (war, bailout). The two are identical.

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Comments

The fact that they now own 5 trillion in mortgages should be disconcerting. If neither exist anymore - the suggestion is that Banks will freeze the housing market.

How about this, let's freeze the "securitization" of the housing market and let Banks make money the old fashioned way, by keeping the mortgages on their books. Yeah, people will need 20% down, stable income, and good credit and the Bank can't lever up. Just exactly what is wrong with that. If people don't have the money to put down - guess what, you are a credit risk.

The money quote and the reason for the bailout is from your NYT picture - "virtually every wall street bank and many overseas financial institutions, central banks and investors do business with Fannie and Freddie."

Posted by: Maj Tom | Sep 6, 2008 7:37:09 AM

Barry, have you seen Armando Falcon's comments? It is interesting: http://voices.washingtonpost.com/washbizblog/2008/09/former_regulator_move_on_fredd.html?hpid=topnews

"I would force the more accurate accounting of their assets and liabilities, and that would show them to be insolvent," Falcon said in an interview.

"The reason you have to do it now is to reduce the cost of resolving the two companies," Falcon said "We know from the savings and loan crisis that forbearance in dealing with insolvent institutions only increases the cost of resolving the failed institutions," he added.

Posted by: SM | Sep 6, 2008 7:38:51 AM

Maj Tom | Sep 6, 2008 7:37:09 AM

With due respect are you crazy. "Freezing the securitization of the housing market" would dry up the supply of retail housing finance almost completely. Hence the roughly five million homes expected to be sold this year wouldn't be sold. Mom wouldn't move into her condo, the Sixpack family wouldn't move to Atlanta, etc. It would cause a crash of 1929 proportions. This takeover is necessary, it's what govt's do to protect their economic systems,
it should have been done months ago, and F/F are neither going to disappear or be privatized.

Posted by: John(2) | Sep 6, 2008 8:20:14 AM

Does the following sound accurate to you follks?

The Congressional Budget Office on Tuesday estimated that a government plan to stabilize mortgage giants Fannie Mae and Freddie Mac could cost government coffers an average of $25 billion.

The CBO said it thinks there is probably a better than 50% chance that the Treasury would not need to step in. It also said there is a 5% chance that Freddie and Fannie's losses would cost the government $100 billion.

CBO's $25 billion cost estimate is an average based on "the path of housing prices in the next several months." They considered three scenarios: prices stabilize, grow modestly or decline steeply.

Posted by: Common Cent$ | Sep 6, 2008 8:28:08 AM

Mark Sep 6, 2008 8:08:54 AM

NZ, nor the UK or France or Germany for that matter, may have an exact equivalent of the FDIC but the notion that the banking systems in these countries is not at least as tightly regulated as the US is bizarre in the extreme. A bit like a lot of the thinking in Atlas Shrugged which is one of the most tedious books I have ever read not to mention most irrelevant in understanding the mixed economies which are the mainstay of the globalized world economic system. It is no accident that one of the prime architects of the current mess is a confessed follower of this strange author.

Posted by: John(2) | Sep 6, 2008 8:30:04 AM

I will be outraged if they give a penny to existing share-holders! I want to get my few thousand $$$ from my short FRE position so that I can offset the tax burden levied on me by these wall street mafias and FNM/FRE CEOs who made lavish $$$ while things were great.

Posted by: free markets | Sep 6, 2008 8:40:14 AM

Barry's earlier comment -- "I suspect this will be another hugely expensive and ultimately unsuccessful attempt to bailout our prior irresponsible profligacy" -- is true on multiple time scales.

This decade will be remembered for the epic Housing Bubble and subsequent bust. Now that particular bit of profligacy is being bailed out. And one shouldn't doubt their ability to do so, and launch the next stunted economic expansion.

But on a larger macro view, Oil Shock I in 1973 tolled the bell for the economic miracle of the 1960s. It was then that real wage growth hit a wall, and what seemed to be a small Asian land war toppled the Bretton Woods fixed exchange rate regime. Since then, weaker and weaker expansions have been fueled by two-earner families, ever heavier levels of debt, and in the final Bubble phase, reckless financial innovations such as black-box CDOs carrying AAA ratings from bribed rating agencies with no liability for being wrong, wrong, wrong.

In every recession and financial crisis for the last 35 years -- since Oil Shock I and floating exchange rates -- the pain of debt default has been treated with the "hair of the dog" -- more debt. Now that corporate AAA credits have almost disappeared, USGOV is one of the last AAA credits on the planet. It can still borrow hundreds of billions for 10 years at the absurdly low rate of 3.66%. Not until this yield soars into double digits will the pain of excessive gov't borrowing (including paying "interest on interest") begin to be felt.

So, exactly as Bill Gross suggested, gov't AAA credit will be substituted in massive quantities for impaired or defaulted junk debt. It's the "hair of the dog" routine, all over again. You can almost hear another click of the gargantuan debt ratchet. And the leveraged speculating community is gearing up to put that government booty to work in Bubble III -- oh, yeah! Pimp my house, Hank! I'm a nothin'-down NINJA, baby!

But ... who's going to bail out USGOV in the NEXT crisis? Nobody. Thus, as Barry R. projected, "soft default" via escalating inflation is the only road out of this suffocating slough. This is how empires die -- slowly. The Brits are still around, but they aren't an empire no more.

When you see all them flags waving in the political conventions -- they're waving goodbye to a prosperous America. Boomers will still get their $1,500 SocSec check, but it will hardly buy a pack of gum. Some will have to sell their bodies to science. Mmmmm, Soylent Green for breakfast! Enjoy!

Posted by: Jim Haygood | Sep 6, 2008 8:43:05 AM

Mark,

he wouldn't know, he hasn't been told.

John(2) sounds like a client of PIM(P)CO.

Posted by: Mark E Hoffer | Sep 6, 2008 9:00:46 AM

One more thing: with effectively nationalized housing finance, USGOV as the dominant lender is going to want rising house prices. Rising nominal prices are the best protection against losses on underwater, short-sale mortgages.

With ongoing foreign conflicts (which ensure continued borrowing and monetization) plus the new political mandate for rising house prices domestically, inflation in the mid to high single digits is a lock -- REGARDLESS of who's chosen to impersonate the president. Cuz there won't be jack that he can do about it.

Posted by: Jim Haygood | Sep 6, 2008 9:02:40 AM

Dr. Zeus Teaches Kids About China and U.S. Finances

I'm Uncle Sam
I'm Uncle Sam
Sam I am

Will you bail me from this jam?
I will not bail you from this jam
I do not trust you Sam I am

But I have home loans
and loans on cars
and I have nukes that shoot near and far

So will you bail me from this jam?
It's all AAA
from Sam I Am

I will not buy your lousy loans
on cars and nukes and empty homes
This is you own mess, your own jam
You're on you own
Sam I Am

Posted by: Winston Munn | Sep 6, 2008 9:08:43 AM

Mark

You have marked your self as a objectivist, meaning that your thinking is flawed and should be ignored.

Personally I'd say any book where the protagonist gets to be the hero by being an jerk-should not be a foundation for a philosophy, or a economy.

My .02$

Posted by: Tom | Sep 6, 2008 9:16:05 AM

Congress gave teamBush a blank check for Iraq and they promised us a quick easy war that would pay for itself with Iraqi oil, look what we have a trillion dollars later (all borrowed of course)

Disregard whatever they say about the cost of the F&F takeover, it will be monumental.

Posted by: jc | Sep 6, 2008 9:25:31 AM

I hope that fellow lovers of freedom and prosperity also realize that the Fundamentalists and the Neo-Cons would be "incentivized" to dispatch a President McCain in order to have an unabashed puppet in the Oval Office.

This nightmare scenario would be all their dreams come true.

After sowing the wind of anti-intellectualism and misanthropy in rural America, we may soon reap the whirlwind of a world plunged in Darkness.

The economics we discuss only describe the process numerically; the process of shaking off the shackles of Civilization is a bloody and murderous affair. Just ask Sigmund Freud.

Posted by: Paul Jones | Sep 6, 2008 9:25:44 AM

Does the government now bail-out commercial mortgages? Where does it end?

Posted by: JustinTheSkeptic | Sep 6, 2008 9:25:46 AM

following on Mark's decent recommendation, I think, the following:
"Western nations including the United States have gradually implemented virtually all of Marx's 10 key steps toward creating a dictatorship. What are some examples can you find? Americans would be wise to study the "Ten Planks" and demand that the President and Congress abolish all laws, regulations and agencies which govern these (and all other) unconstitutional seizures of power. Communism was never intended to free man, but to enslave him; indeed the Communist Manifesto promised a "dictatorship of the proletariat" and history proved it always ended up slaughtering millions of the proletariat.

Karl Marx's "10 Planks" to seize power and destroy freedom:

Abolition of Property in Land and Application of all Rents of Land to Public Purpose.

A Heavy Progressive or Graduated Income Tax.

Abolition of All Rights of Inheritance.

Confiscation of the Property of All Emigrants and Rebels.

Centralization of Credit in the Hands of the State, by Means of a National Bank with State Capital and an Exclusive Monopoly.

Centralization of the Means of Communication and Transport in the Hands of the State.

Extension of Factories and Instruments of Production Owned by the State, the Bringing Into Cultivation of Waste Lands, and the Improvement of the Soil Generally in Accordance with a Common Plan.

Equal Liability of All to Labor. Establishment of Industrial Armies, Especially for Agriculture.

Combination of Agriculture with Manufacturing Industries; Gradual Abolition of the Distinction Between Town and Country by a More Equable Distribution of the Population over the Country.

Free Education for All Children in Public Schools. Abolition of Children's Factory Labor in it's Present Form. Combination of Education with Industrial Production."

makes for interesting reading during times such as these.

I suppose that makes me a Communist, Tom?

Posted by: Mark E Hoffer | Sep 6, 2008 9:32:22 AM

Hyper-stagflation!
TeamBush doubled the national debt in their first 7 years and it's going out with a half trillion dollar deficit.

Now they take another 6 trillion onto the government books plus Fed rate loans to banks, brokers and soon $50B to the almost insolvent Big 3.

The current $300B debt servicing cost is going to explode, it's already the third highest expenditure, what happens when both the principal amount and the interest costs move up in tandem? A trillion a year in debt servicing?, what institution can survive with debt servicing cost as their largest expenditure. Welcome to Weimar Amerika! The choice will be US federal borrowing default or hyperinflation to pay off the debt with largely worthless dollars.

It'll be hyperinflation because its largely en train, and inflation can always be blamed on vague "others", it's takes a "buck stops here" type of President to default and they're hard to find.

Posted by: jc | Sep 6, 2008 9:43:13 AM

Interesting...but I read Atlas Shrugged and liked it...didn't think it was tedious...(tedious is Moby Dick)..

Rand came from a communist background..and the book isn't a novel...it is social commentary and should be viewed as such...

Books like Animal Farm, Atlas Shrugged, The Prince...why would you criticize someone whose has digested these novels? They can offer insight, and then you make up your mind about the worthiness of what was offered...

It is about discourse, not personal attacks.

So what if John Galt is your anti-hero, and not your hero? At least he remained true to his values..Has Paulson?

Bruce in Tennessee

Posted by: Bruce | Sep 6, 2008 9:56:18 AM

The upcoming election creates problems in trying to pull this off, but does anyone believe that they are going to inject money quarter by quarter? Under this plan, every quarter that they inject capital will create rumors of insolvency, shake markets up, etc. The only way to make this work is to be as forthright as possible and inject enough capital to give them a shot at success. I remember Paulson sitting in China saying that there were no plans to inject capital. Now, three months later here we are. Does anyone have confidence in this crowd.

Posted by: larster | Sep 6, 2008 9:58:32 AM

Can I ask a naive question - what do people think will happen in the markets on Monday? On the one hand I could see the market interpreting this as very bad, on the other, I could see it as the equivalent of a Fed move.

Posted by: Damian | Sep 6, 2008 10:08:09 AM

"With due respect are you crazy. "Freezing the securitization of the housing market" would dry up the supply of retail housing finance almost completely." (John (2))

The sister-in-law works in a car dealership. She said there is no business. 60% was leases and there are NO leases. For the balance, the buyers are NOT qualified for a loan on those expensive models so they are trying to push USED cars.

It is already happening in autos so why is housing different? Just like used cars there are plenty of apartments available.

Posted by: me | Sep 6, 2008 10:21:09 AM

"It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning" - Henry Ford

"Most Americans have no real understanding of the operation of the international money lenders. The accounts of the Federal Reserve System have never been audited. It operates outside the control of Congress and manipulates the credit of the United States" -- Sen. Barry Goldwater

"We have, in this country, one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board. This evil institution has impoverished the people of the United States and has practically bankrupted our government. It has done this through the corrupt practices of the moneyed vultures who control it". -- Congressman Louis T. McFadden

Posted by: km4 | Sep 6, 2008 10:22:30 AM

"what do people think will happen in the markets on Monday? "

Damian I think it is an admission of how bad things are in the economy, ergo buy, the market will skyrocket. It always does the opposite of what I expect.

Posted by: me | Sep 6, 2008 10:22:50 AM

Barry,

I don't know if anyone else has posted this, but on the Mises Institute website is an article, authored by Don A. Rich, on the "Real Cost of a Full Bailout":

http://mises.org/story/3062

Posted by: Strasser | Sep 6, 2008 10:30:46 AM

I shuddered as Congress gave them a blank check but I thought the blank check stopped at the debt limit. Am I wrong or is everyone assuming Congress will raise the debt limit without debate?

Posted by: Anna Lee | Sep 6, 2008 10:34:23 AM

BR, or anyone for that matter, have you read Jim Creamers take on the bail-out. He seems to think that this is going to put an end to the free-fall in home prices. I just don't see it. His arguement is that there are so many more people living in this country now then 20 years ago, so the historically high home inventory will be eaten up by the larger population numbers. Seems like a very simplistic arguement to me when the unemployment numbers are just beginning to get bad and will take another 10 to 16 quarters to bottom. Yes, mortgages may become more available, but will that matter?

Someone smarter than me...help me out on this one!

Posted by: JustinTheSkeptic | Sep 6, 2008 10:45:21 AM

December 2008
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7	8	9	10	11	12	13
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Roundup: Fannie & Freddie Bailout

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