The Times appears to have broken the story (hat tip reader Saboor) that the Treasury is seriously mulling an emergency cash injection into the troubled mortgage giants Fannie and Freddie in the form of some sort of senior equity (the article is not clear on this point, but the Wall Street Journal had mentioned a similar idea, a preferred issue that would be designed to dilute common shareholders).
If this unsourced report proves accurate, it indicates how serious the situation is. The immediate test is a scheduled Monday $3 billion short-term debt sale by Fannie (the Times article has a confused description in a section I chose not to include) . If that were to go well, it would alleviate some immediate pressure. And one would think it would not be all that hard for the Fed and Treasury to place a few calls and suggest that supporting this fundraising might be in everyone’s best interest. The move to more drastic measures is not a good sign.
And let us not kid ourselves: this is a fig leaf, not a solution. This move would acknowledge that the GSEs are undercapitlized without giving them enough equity to function as independent, self-supporting financial institutions. It affirms the implicit guarantee without formalizing it. It is a creeping nationalization that leaves management in place and provides no improvement in accountability or oversight. And it fails to resolve the ambiguities that created this problem in the first place: the GSEs are expected to operate like independent, profit-minded financial institutions yet serve collective aims. Indeed, this non-solution solution may have the unintended side effect of encouraging Congress to make yet more demands of Freddie and Fannie to rescue the housing market since they are now arguable stronger and adequately capitalized, and thus precipitate another crisis of confidence in even shorter order than would otherwise occur.
This plan would be entirely in keeping with Willem Buiter’s description of Comrade Paulson as a promoter of dishonest socialism and excessive support of real estate.
But this sort of measure would be entirely consistent with one of the Bush Administration’s prime objectives: to kick as many cans down the road as possible so they become the problem of the next regime.
From the Times:
US Treasury secretary Hank Paulson is working on plans to inject up to $15 billion (£7.5 billion) of capital into Fannie Mae and Freddie Mac to stem the crisis at America’s biggest mortgage firms….
The capital-injection plan is said to be high on a list of options being considered by regulators as a means of restoring confidence in the lenders. The move would protect the American housing market, but punish shareholders in both companies.
Under the terms of the proposed move, the US government would receive a new class of shares in exchange for the capital, which would be hugely dilutive to shareholders.
The potential rescue comes as investors are braced for more bad news from the financial sector. Citigroup is expected to reveal further writedowns of at least $8 billion with its second-quarter results, and Merrill Lynch is forecast to reveal writedowns of some $4 billion….
The capital injection would also see both lenders granted permission to use the Federal Reserve’s discount window – a short-term emergency funding source…
Some in Wall Street believe a rescue plan may be announced ahead of tomorrow’s US market opening to calm nerves and support the debt auction.
Howard Shapiro, a Wall Street analyst at Fox-Pitt Kelton, said: “I think it will happen over the weekend. There will be government action but it will be far short of the dire scenarios that people are envisioning.” He said there was “no question” that the two firms were fundamentally sound.
He added that Paulson would have to move in order to “change the psychology” of the market and put Fannie and Freddie back on a stable footing.
David Buik, partner at BGC Partners, said: “These agencies are the backbone of financial society in the US. They simply cannot be allowed to fail, and the government won’t allow them to fail. Whatever the solution is to this problem, I can’t imagine it will be good for shareholders.”
He added: “In London we may see a dead-cat bounce on Monday, especially if we get a rescue. But that’s all it will be – shares may pop up 50 points or so, but then they will head down again.”….
Robert Parkes, UK equity strategist at HSBC, said: “It’s a seller’s market – we’re generally advising clients to sit on the sidelines until all the current issues blow over.”
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heckuva job Hank.
Short Bucky!
With only five months left to govern should or could the Bush administration do anything more than take emergency steps to prop up the GSE’s? Would Congress be responsive to a fundamental reform proposal right now? Is something this significant best left to a newly elected President and Congress who would theoretically represent the current political will?
Tom,
The problem of the GSE’s undercapitalization and problematic status has been well known for years. It just happened to come to a crisis now, but it could just as easily have come to a head in any of the previous acute phases of the credit crunch. As soon as things got bad last August (if not years before) the GSEs should have gone on the front burner.
And there is plenty that could be done. Henry Kaufman called for forming a bi-partisan committee and issuing a report on financial supervision reform (a much bigger and hairier topic) by October. You could have a GSE initiative formed by the end of July and report in by mid-late September. The Brady Commission, which investigated the 1987 crash (remember, they had to do considerable fact gathering) was formed by an executive order of Reagan on November 5, 1987 and issued its report and policy recommendations on January 8, 1988.
But this administration doesn’t do bi-partisan and it doesn’t like facts or investigations much either.
This Administration also seems perfectly willing and able to take on major commitments that it should not even be thinking about, namely a war with Iran. If that is on the table, I don’t see how they have any excuse not to get serious about the GSEs. For instance, a debt restructuring along the lines suggested by Roubini (which we know will never happen, but it serves as a useful illustration) could be implemented between now and next January.
Nothing ever is George Bush’s fault. He was brave fighter pilot in Texas and is a self-made millionaire. He never trafficked in his family name.
Who could have known terrorists would fly planes into buildings? Who could have known that a hurricane could breach the levees in New Orleans. And who could have know the GSEs were trouble until this week.
Thank God that Antonin Scalia and Clarence Thomas were on the Supreme Court back in 2000 to put this greates of men in the highest office in the land.
anon of 11:05 pm.
Are you seriously suggesting that Albert Gore, Jr., could have done a better job?
Ask the people of his home state, who declined to vote for him in 2000. Had he carried his home state, Florida and the Supremes would have been unnecessary.
Nuf said.
tomd
But this administration doesn’t do bi-partisan and it doesn’t like facts or investigations much either.
With the exception of issues of national security and foreign affairs, most of the powers that we attribute to the Executive (e.g. OTS) have actually been delegated by Congress. So while I understand that much of the blame should go to GWB’s Administration, some of the blame should go to the Democratic Congress, especially since they marched into Washington in 2006, with the implied mandate to check the Executive Branch. If Congress is going to delegate its authority, it needs to use its oversight hammer. As subprime was melting last summer, all I remember Congress doing was investigating the abuse of steroids by MLB.
If true, it will be interesting to see if Treasury forces them to eliminate common dividends (or are they already gone?).
Interesting.
$15 billion isn’t enough for Freddie alone, much less the two of them. Isn’t there the risk of making the situation worse by trying a half-measure that fails quickly?
Order of magnitude I’d been thinking you needed to throw down $60-$80 billion of real equity capital to make a strong statement — which really isn’t all that much money under the circumstances.
This is starting to make my head hurt.
Yves,
All valid points but I still have to ask if it is fundamentally right to tackle this problem completely in the last days of a lame duck administration.
By your own admission, the system requires not only a temporary fix but a complete overhaul of the GSEs, if not their elimination. That’s a tall order and one that ought not to be made in haste nor, in my opinion, should it be tackled by politicians who are soon to be replaced.
This crisis is amenable to a temporary fix. After the election, truly meaningful and well considered restructuring can occur.
The $15 billion is capital — which can be leveraged who knows how many times but I would suspect to a minimum of 10x — so you are talking about an additional $150 billion in losses that can be foisted on the taxpayer.
I think we lose that much in Iraq each day in payments to various Shia and Sunni outfits so Dick Cheney can say ‘Al Qaeda is in its last throes’
BTW, I believe that Al Gore did carry Flordia but we will never know because the strict constructionists on the Supreme Court blocked a full recount.
Good thing those strict constructionists think using $150 billion in taxpayer money is allowed under the Constitution.
If you really want to get upset about Florida, go read Greg Palast. He writes like an unreconstructed labor organizer, which discredits him in a lot of people’s eyes (we in the US demand that investigative reporters adopt an anodyne writing style), but he has gotten numerous awards and reports for the BBC.
He researched voter fraud in Florida in 2000. Florida (and remember Jeb was governor) hired the most expensive bidder on a contract to scrub felons from voter rolls. Florida is one of those states where felons can not vote (aside: I don’t get that concept, once you have served your time, you have paid your debt to society).
Anyway, the firm hired got shall we say creative in how it scrubbed voter rolls, pulling in people who had merely committed misdemeanors and those whose names resembled those of felons. The results got rid of far more black voters than were felons. Note not all counties accepted the states’ purge list. One county bothered checking the list and found it had a 95% error rate.
Blacks vote 90% Democratic. Palast, using the turnout rates of black in Florida in 2000, estimates that this procedure cost the Democrats 22,000 votes, versus a bit over 500 for Republicans.
15 billion? I agree with anonymous. This isn’t serious money, and Fannie and Freddie are going to be paying a huge mark-up the next time they borrow on the market. This will begin to starve them of funds. This thing (a rescue) needs to be done quickly, if it is to be done well. Roubini’s arithmetic works out well, recapitalization on the order of 300 – 400 billion, funded by haircuts on existing bonds. (And even though I agree with Roubini, let it be noted that talk of a haircut by any serious participant is more than likely to be a catalyst for the GSEs to have problems to raise funding; no one wants to invest money and then see an immediate loss of 5 or 10%. It really needs to be done *quickly* and *massively*.)
The 2000 election bickering is silly. When both parties put up candidates who insist on maintaining the “special relationship” with the U.K. the electorate has zero choice. Same goes with this year’s election. Nuff said.
Why is no one analyzing this GSE situation from the perspective of the well-demonstrated policy of the Bush administration: controlled chaos in behalf of ideological allies among the aristocratic set? Contrarily claiming “one of the Bush Administration’s prime objectives [is] to kick as many cans down the road as possible so they become the problem of the next regime” does not strike me as an all that rigorous analytical conclusion.
And why is no one calling into question the uber-securitization of private credit markets and the consequent ratcheting up of leverage? Am I to believe all the crap created in the process represents legitimate claims worthy of being saved?
As far as I am concerned the arrangement much more greatly benefited a few and OBVIOUSLY threatens to be the detriment of many. This outcome is no great surprise and so begs the most important question of all: was it all planned to end this way and are those who play weak parts in bringing about resolution, in fact, traitors to the principles for which the U.S. was formed?
Given the craven cowardice of this Admin, a cynic would suggest that they have fallen victim to a standard squeee/protection racket.
Short the hell of the stock of a company, buy up all its bonds or other non-equity obligations (engage it as counterparty on swaps/swaptions) and then watch the Bushies use the legacy of our grandchildren to lock in a profit for your.
Just a variant of the reverse LBO scheme.
To a at 1:30, you again raise a cogent point regarding Roubini’s proposal which crossed my mind but hasn’t been noted before. If existing GSE bonds take a haircut of any kind, how does this NOT make selling further GSE debt harder and more problematic? I have no problem whatsoever with cutting LEH and CITI bonds if, when, and as they have to be taken down by the public. The GSEs are categorically different enterprises, and their debt has functioned as quasi-public $-denominated securities for years. We can quibble all we care to regarding the ambiguity/explicit renouncement of goverment guarantee of GSE bonds, but this strikes me as neo-liberal privatization fabulation: the GSEs were from their inception understood to be government enterprises, by everyone, at every level. The reasons for having them be ‘quasi-public’ have more to do with keeping them out of Congresses sticky fingers, and using their guaranteed profitability to reward government friendly investors, y’know, The American Way.
. . . How does cutting these bonds NOT have a severe negative effect on the dollar?? The proposal just does not seem to me to have been thought through—or it never would have been uttered.
On July 12, 2008 @ 11:22PM, tomd said…
Are you seriously suggesting that Albert Gore, Jr., could have done a better job?
Without any doubt or hesitation, I say that Albert Gore Jr would have done a spectacularly better job than the current occupant of the office.
Even the briefest review of the catalog of crimes, misdemeanors, errors of judgment, omission, and comission, and acts of plain idiocy of the individual currently ensconced in the Oval Office lead any thinking person to that conclusion.
David T. Davis
Cody, Wyoming
“If existing GSE bonds take a haircut of any kind, how does this NOT make selling further GSE debt harder and more problematic?”
As Roubini says, the best time to lend to someone is *after* they restructure. Current bondholders always argue against restructuring by saying that if it goes through, they won’t lend any more money. But this is just talking their book, and the historical record shows it is false, and they are *more* willing to lend their money afterwards, because the enterprise or entity is now on more solid footing.
So, I would: force through a big haircut on the bondholders; have the U.S. government at the same time guarantee the debt; and wind the GSEs down over a twenty- to thirty- year period.
Forcing through a huge haircut IMHO is dollar positive. A lot of those losses will be born by foreigners. So while it may not be so good for foreign relations (the Chinese will be extremely pissed), the U.S. is overall shedding debt.
Sorry just to be clear: talk of a haircut makes it much harder to raise money, because bondholders will be worried about it coming and won’t want to suffer. On the other hand, actually putting the haircut through makes raising money easier, because all the new bondholders benefit from the increased stability of the entity.
*Sigh* So a, one aspect which I did not take up in Roubini’s post was the unhealthy smack of Dirty Furrinerism. But I have to come back to it in light of your comment. I’m just not clear if you _really_ grasp what it would mean for the US to UNILATERALY force a haircut on sovereign foreign central banks and quasi-government entities. They are funding our trade deficit. They are substantially underwriting our Treasury debt, and at very low premiums one might add. Forcing losses on them when they have been, for a year and at probable mid-term losses through dollar conversion, funding our domestic financial system, is an incredibly hostile action. Why don’t we just nationalize their owned US assets instead? That would provide us with some capital, right? If I didn’t have to live with the consequences, too, I would LOVE to let you and Roubini live through the consequences of this one, but on second thought, no.
And on the issue of folks lining up to buy GSE bonds after getting a few joints knapped off their fingers, well maybe. But. They are going to ask for more of a risk premium, or would be damn fools not to. They are going to hold that debt with less confidence. And frankly, they will get burned again the next time the US writes down primary financial assets, because once you have the _successful_ precedent it will certainly be resorted to again when domestic financial or political circumstances become high-pressure.
It is all wonderful theory until one gets back 95 (or 90 or more likely 80) cents on the dollar; after that, business decisions get sharper edges by our international counterparties. Here’s a question for you: does Indonesian and Argentine sovereign debt trade at lower premia now relative to 1995? Oh but that’s right: they are _minor_ economies while the US is the exceptional economy. Don’t bet on that with your own money. I think, in a phrase, that Roubini is talking through his hat because he is more than willing to kick our foreign couterparties in the shins for whatever reason. They can kick back. They can take their football and go home. They don’t want to, but if we give them reason enough we’ll find out what the game is all about.
“an incredibly hostile action”
Well, it would be if you thought that the U.S. government had some moral or legal responsibility to bail out the GSEs. I don’t. In fact the U.S. gov has made it very clear that the full faith and credit is *not* behind the bonds. If investors never wanted to listen, then how does it become the U.S. taxpayer’s problem?
“They are going to ask for more of a risk premium, or would be damn fools not to.” I don’t think there will be any premium, but in any case that wouldn’t be the measure. The measure is vs the haircut. So let me ask you, Do you think that the cost of the risk premium would be more than the haircut?
“the next time the US writes down primary financial assets” Again, you seem to be supposing that the GSEs have the full faith and credit. They don’t and they shouldn’t be treated as such.
“They can take their football and go home.” Uh, well, let them if they want. Your reasoning boils down to: the U.S. taxpayer should be on the hook for hundreds of billions because otherwise foreigners won’t be happy about losing money in a mistake of their own making. No one’s happy about losing money, but that’s capitalism.