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Substantial Implicit Subsidy to GSE Shareholders "Unwinding"

I came across an interesting Fed paper the other day from 2005. It looked at how much subsidy was built into shareholder's equity of Fannie Mae (FNM) and Freddie Mac (FRE) due to the government's implicit backing.

Given today's market action was blamed on the two GSEs, its apparent that the previous "implicit subsidy to GSE shareholders" is not only less implicit, but it may be evaporating altogether. 

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charts via Divisions of Research & Statistics and Monetary Affairs, FRB   

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Let's go to some deep research on Fannie Mae (FNM) and Freddie Mac (FRE):

The housing-related government-sponsored enterprises Fannie Mae and Freddie Mac (the “GSEs”) have an ambiguous relationship with the federal government. Most purchasers of the GSEs’ debt securities believe that this debt is implicitly backed by the U.S. government despite the lack of a legal basis for such a belief. In this paper, I estimate how much GSE shareholders gain from this ambiguous government relationship.

I find that (1) the government’s ambiguous relationship with Fannie Mae and Freddie Mac imparts a substantial implicit subsidy to GSE shareholders, (2) the implicit government subsidy accounts for much of the GSEs’ market value, and (3) the GSEs would hold far fewer of their mortgage-backed securities in portfolio and their capital-to-asset ratios would be higher if they were purely private.

The calculation formulas used in this Fed research paper are beyond me, but the charts are rather self explanatory.

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Why would a Barron's article, with no new information in it, send Fannie down 22% and whack 2% off of the markets? 

Once again, we are forced to ask, What Efficient Markets?

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Previously:
Fannie and Freddie: Worth Negative $50 Billion Each (August 2008)
http://bigpicture.typepad.com/comments/2008/08/fannie-and-fred.html

Source:
The GSE Implicit Subsidy and the Value  of Government Ambiguity 
Wayne Passmore
Federal Reserve, 2005-05   
Finance and Economics Discussion Series Research & Statistics and Monetary Affairs
http://www.federalreserve.gov/pubs/feds/2005/200505/200505pap.pdf

Monday, August 18, 2008 | 04:15 PM | Permalink | Comments (7) | TrackBack (0)
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Comments

"Why would a Barron's article, with no new information in it, send Fannie down 22% and whack 2% off of the markets?"

1. Because it was sourced from someone at the Treasury department.
2. Because it mentioned prefered shareholders will also take a big hit. That's new and bad news for the banks.
3. Because delusional common equity holders don't understand that a capital raise from the government will de facto wipeout their stakes.

Posted by: Ugh | Aug 18, 2008 4:31:33 PM