The New York Time reports that the Federal government is leaning towards conservatorship as the approach for handling Freddie and Fannie’s shaky finances. Under this scenario. shareholders are wiped out and taxpayers fund any losses.
What I find disturbing about the mainstream media coverage is the refusal to connect the dots between the increasing demands placed on the GSEs by Congress and the negative reaction in the market. This is pushback, pure and simple, against efforts to finesse a Federal bailout of housing by pushing as much as possible on to Fannie and Freddie, rather than set up new programs so the costs would be explicit.
There are no free lunches, particularly in times like these.
From the New York Times:
Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday…..
Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.
The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.
Yves here. So the Feds believe that the markets can be fooled by off balance sheet financing. Back to the Times:
The officials also said that such a step would be ineffective because the markets already widely accept that the government stands behind the companies….
The officials involved in the discussions stressed that no action by the administration was imminent, and that Fannie and Freddie are not considered to be in a crisis situation…..
Under a 1992 law, Fannie or Freddie could be put into conservatorship if their top regulator found that either one is “critically undercapitalized.” A conservator would have sweeping powers to overhaul them, but would not have the authority to close them….
In recent weeks, the companies have spiraled downward, undermined by declining confidence in their future and shaken by sharp declines in their assets as the housing markets have continued to slide and foreclosures have risen.
In the last week alone, Freddie has lost 45 percent of its value, and Fannie is off 30 percent. Expectations of default at the companies have also risen; it costs three times as much today to buy insurance on a two-year Fannie bond as it did three years ago.
Analysts expect the companies to announce a new round of write-downs and possibly be forced to raise capital by issuing additional shares, which would dilute their value for current shareholders.
Despite repeated assurances from regulators about the financial soundness of the two institutions, financial markets have concluded that by some measures they are deeply troubled.
Freddie, for instance, is technically insolvent under fair value accounting rules, in which the company puts a market value on assets as if it had to sell them now……
Although Treasury Secretary Henry M. Paulson Jr. and Ben S. Bernanke, the chairman of the Federal Reserve, passed up invitations by lawmakers on Thursday to seek legislation to deal with the crisis, officials said that the administration had been privately considering a government takeover should the markets continue to turn against the companies….
At a hearing of the House Financial Services Committee on Thursday, both Mr. Paulson and Mr. Bernanke were guarded…
Neither official would address a question posed by Representative Dennis Moore, Democrat of Kansas, who asked whether the failure of either institution would pose a risk to the financial system.
“In today’s world I don’t think it is helpful to speculate about any financial institution and systemic risk,” Mr. Paulson said. “I’m dealing with the here and now, and the important role that they’re playing and other financial institutions are playing.”
So Paulson couldn’t even muster a convincing lie, and ducked the question clumsily. That give you the answer right there.
Update 4:40 AM: Further discussion:
Fannie and Freddie Waterfalls Are Too Big to Bail Michael Shedlock
NYT: Freddie/Fannie Takeover Talks Heat Up. Voom Needed Paul Kedrosky
In Large, Red, Friendly Letters it Reads, “Don’t Panic!” (GSE Edition) David Merkel
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They won’t speculate, because the thought of FNM or FRE failing is just to catastrophic to think about. Think about it. The failure of Fannie and Freddie would essentially render the U.S. government insolvent.
Yves, I hope you’ll address more the ramifications of these two failing for the market, the economy, and the world as we know it.
Just so. How much of a devaluation would doubling the national debt cause? 25%,50%?
As a guess, we could see at least $2/Euro before the newsprint had dried.
Of course, housing would — suddenly — be fairly priced in “nominal” terms.
On the other hand, if goods other than existing mortgages cost 25%-50% more, I’m pretty sure we could expect a significant slowdown in the economy as well. :(
I think the Government will not explicitly bail out Freddie and Fannie, but it will offer a more explicit guarantee, guaranteeing their low cost of funding. Since most likely this crisis too shall pass, will relatively minor nominal damage (remember that Bernanke will support the Financial system with liquidity and guarantee at almost any cost, if he is consistent with what he has written about the great depression) they will be fine in a couple of years.
As an aside, what is the incessant idiotic, naive and hypocritical blather about the “tax payer cost of a bailout” ? Does anybody remember that widespread homeownership in this country is largely a product of the implicit subsidy given to Fannie and Freddie? Overall netting potential “tax payer cost of a bailout” from the societal benefits of homeownership I think the US is ahead.
I happen to think that the government has already decided to bail them out. They decided months ago but the story is only just now leaking out.
from my post: Everyone should recall that Fannie Mae and Freddie Mac were forced to massively increase their already bloated balance sheet in the aftermath of the Bear Stearns collapse. It seems reasonable to me to assume that the two organizations did so only because they were given an implicit guarantee at the time by the government officials involved.
Is the Fannie-Freddie debacle the result of a backroom deal?
Iv, I hope you are being sarcastic, but it doesn’t seem like it.
The societal benefits of the petroleum-intensive urban sprawl that has spread across the American are overrated. Parents don’t even let their kids go out and play anymore.
Also the existence of Fannie and Freddie caused house prices to inflate much more than they would otherwise.
I know you have issues with the WSJ but they have been ranting about the outsize risk the GSE’s pose for more than a few years. They appear to be getting some vindication. I’m sure you saw the editorial they had today on the subject. Their proposal to recapitalize them through a government purchase of preferred equity in order to get them back on their feet and then strip them down to a manageable size has some merit. HousingWire also had a useful and more analytical article on the subject as well. I included links to both in this article-http://blog.metro-real-estate.com/?p=694.
Re: “senior Bush administration officials”
What they mean there, is that SIFMA is telling people in the current administration how the mechanics of a bailout to its members will be phased in. Make no mistake, SIFMA wrote the Pension Protection Act and is behind every move made by this puppet government.
Go to to The SIFMA webpages if you want details on this bailout! of criminals, who had the backing of the current administration to look the other way on The Tsunami of bullshit liquidity that flooded every casino in America!
The US Government is ALREADY insolvent. They just pull the same off-balance sheet shenanigans as Fannie and Freddie do. The US Government has over 62 Trillion dollars now (present value) of unfunded liabilities. It keeps these off its balance sheet for the same reason that Fannie and Freddie keep obligations off their balance sheets. People are talking about FRE and FNM 5Trllion dollars of debt and that damage that would do to the US Government’s fiscal position, my god man, that is only 8% of that 62 Trillion that David Walker was warning us all about. They’re all insolvent. Period. It’s just a 3 card monte con game….a modern day ponzi scheme of monstrous scale.
Underground economy here I come.
Ed,
I have to disagree with you.
First, as we discussed in an earlier post, the trouble with Fannie and Feddie became acute in February, when agency spreads rose in reaction to Fannie and Freddie ceilings being increased, before the Bear crisis, par a chart and narrative in this post:
Similarly, on March 17, I quoted reader Lune who gave a nice recap of unintended consequences:
1) Congress raises conforming limits on Fannie/Freddie to help unfreeze the mortgage market. Result: agency spreads skyrocket, bringing down Bear and a host of hedge funds. Mortgage markets still remain frozen.
2) Fed opens TSLF to unfreeze mortgage market. Result: Carlyle goes bankrupt as people rapidly arbitrage the difference between holding MBS in firms that can and can’t access the new credit facility. Mortgage markets remain frozen.
That is a long way of saying the acute trouble with Freddie and Fannie predates Bear and contributed to, if not caused the Bear meltdown. But yes, I am sure the powers that be have been thinking about this problem for a while.
But it is still not clear if the decisions got specific till now. They could have had drones working on background papers but not come to conclusions. Remember, we’ve had a couple of months of “the crisis is past” talk not just from the officialdom but also from bank CEOs. I think they started to believe their own PR.
More important, despite your stress on the role of Fannie and Freddie being authorized to buy more mortgage paper, they have not made any dramatic changes in their balance sheets. Have a look atFannie’s monthly activity report. Ditto Freddie, In fact, Freddie’s portfolio growth rate was lower in 2008 than 2007.
This isn’t the first time that the GSEs have been given authority that they haven’t used or have use so little that they have been criticized. Jumbos is another example.
And the idea of a backroom deal to “nationalize” Fannie and Freddie strains credulity. It is a given that they will not be permitted to fail. Even Jim Hamilton, who as readers have pointed out stay well within conventional lines of thinking, said so back in August. So what would management gain? They can’t be promised what they’d really like, which is special golden parachutes, and they know they won’t be allowed to go under. So what inducement could they provide, particularly a lame duck Administration? It isn’t even clear they could deliver on verbal offers.
Whoops. apologies for the typos above.
Back of the envelope, nationalizing or explicitly guaranteeing the debt of FRE and FNM will raise the national debt by 80%. Congress and the Administration will play any games they can to avoid this. They don’t care about share price; they’ll only act if agency spreads go nuts. We’re not there yet.
Yes, Fannie and Freddie had been in trouble for some time. And they contributed to the Bear meltdown. All the more reason to wonder why they would allow the two organizations to reduce capital-surplus requirement to 20% from 30%.
You said:
“1) Congress raises conforming limits on Fannie/Freddie to help unfreeze the mortgage market. Result: agency spreads skyrocket, bringing down Bear and a host of hedge funds. Mortgage markets still remain frozen.
2) Fed opens TSLF to unfreeze mortgage market. Result: Carlyle goes bankrupt as people rapidly arbitrage the difference between holding MBS in firms that can and can’t access the new credit facility. Mortgage markets remain frozen.”
I say — look, politicians are not looking or market solutions. They are looking for political solutions. It’s not a matter of whether the markets would react positively in the GSEs debt markets but rather whether liquidity could be supplied to the mortgage market. ALl they care about is making sure they react to the mortgage crisis in a way that is beneficial to their party in an election year.
The GSEs could be forced to the tale out of political necessity. I you remember, back in this town, Richard Baker (D-LA) chairman of the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, introduced H.R. 2575– to change and significantly strengthen regulation of Fannie Mae and Freddie Mac.
This was after the accounting debacles
and Enron. I know for a fact because I talked to people at both places that they had regulators, lawyers and accountants in there night and day for years. The bills were mounting. Any political pressure regarding scrutiny could reasonably be made even by a lame duck administration. After all it was the Democrats who were after Fannie and Freddie the first time around.
As far as balance sheet growth is concerned, its not the balance sheet growth itself, it’s what’s on the balance sheet — the type of assets they are taking onboard are of a inferior quality.
From where I sit in DC, t is entirely reasonable to believe that political pressure was applied and a deal was made.
However, as you say, there was nothing binding about the arrangement. There couldn’t be
When the Power Goes Out and Other Lessons.
http://thegreatloanblog.blogspot.com
Keep up the great work! Daily read for me.
11:10 PM
One other thing: the scenario I posted on my blog is identical it seems to what is being proposed and I wrote this before I had read the proposal. It was only after I read the link that I realized what was proposed in full.
I think there will be significant push back from Democrats on this issue however. They may float this idea in this form but I think it is fairly transparent.
MBS’S and Freddie and Fanny bond holders are probably the main short sellers here. How better to get a government guarantee and increasing prices of those bonds then take the equity holders out. Bear was no different. Mortgage insures are toast no need for them.
Ed,
It appears you did not look at the activity reports even though the links were provided. They show both purchases and sales broken down by category. There is no evidence of unusual activity in March, April or May, and it would take a higher level of activity to have had much impact. But you prefer theories rather than seeing if the facts bear them out.
You also failed to address what consideration could be offered to the managements of Freddie and Fannie. They so far have been pretty intransigent. Mudd has been pressured to raise equity and has not done so to the degree desired. And as noted, they have only half heartedly (if at all) acted on Congress’ plans to have them rescue housing.
I don’t see how the Feds have any leverage over Freddie and Fannie. They know they will be bailed out. They also know in any kind of rescue scenario. per Paulson insisting on $2 per share for Bear (and recall that deal did require shareholder approval, while the Feds have statutory authority to put the GSEs into receivership) that their equity is worth nada in any kind of bailout. It is a political necessity that the shareholders, including management, are wiped out if taxpayers have to come to the rescue.
Fannie and Freddie hold the cards. They win in a game of chicken until their position becomes completely untenable. No one will shut them down until absolutely necessary. A hedge fund guy sent me a newsletter which worked through what happens if either of the GSEs is put into custodianship or otherwise bailed out. Gold goes through the roof and the dollar and stock markets plummet. The language was far more extreme than what I just wrote, BTW.
So management’s best financial opportunity is to see if they can ride the housing crisis out as a semi-private enterprise. If they do, their stock holdings will recover. And as self-serving as that is, it’s also in our collective best interest.
So their covert resistance to the efforts to make them the rescuers of housing make perfect sense.
In fact, the conspiracy theory I prefer is that this panic actually serves the Bushies’ interests, provided they can contain it (the problem is that Poole, always a loose cannon, weighed in at the worst possible time). They are very anti rescues of the housing market of any sort. If they can make everyone realize that Fannie and Freddie are too wobbly to do much (which is actually true, randomly the Administration does have the correct position on this one), they will be able to block housing bailout initiatives.
FYI, my view has been if one must go this course, (and I am not a proponent) the way to do it would be via a new agency. You can’t muddle the mission of bodies dedicated to at least attempting to do reasonably high quality loans with ones in the salvage business. They require different skill sets, and should have different financial structures too.
“my view has been if one must go this course, (and I am not a proponent) the way to do it would be via a new agency.”
And, I think, this will be much cheaper to the American taxpayer. Worse for the IBs. That’s a twofer.
I will try a half coherent and typo-free response here as time is short.
You say:
“In fact, the conspiracy theory I prefer is that this panic actually serves the Bushies’ interests, provided they can contain it (the problem is that Poole, always a loose cannon, weighed in at the worst possible time). They are very anti rescues of the housing market of any sort. If they can make everyone realize that Fannie and Freddie are too wobbly to do much (which is actually true, randomly the Administration does have the correct position on this one), they will be able to block housing bailout initiatives.”
I agree. That’s what I am getting at. The Bush administration does not want to be seen as bailing anyone out. As you say, they are anti-rescues (although their language on that has changed of late). They would prefer a back-door version like the one being proposed and block the housing bailout initiative. This is why I believe this plan had been drafted in outline form way before (Jan, March?). Now they are only beginning to flesh out the details on that outline because of the market turmoil caused by Lehman and Poole.
I don’t prefer theories. It does remains to be seen what type of activities the GSEs have been in engaging in since March. That said, it is purely conjecture on my part that they have been buying up lower quality assets. Only time will tell. I can’t imagine that the quality of the assets they are taking onboard is high given the housing market deterioration. I looked at the 3-page pdf that you linked to, but it obviously can’t give any measure of detail as to asset quality. You will notice however that FNM alone funded $327 billion of new business in 2008, over $190 billion since March. In Table 3, they also purchased $18 billion of new MBS. There’s plenty of scope there for taking on junkie assets.
But that’s either here nor there. The crux of what I am saying lies in the fact that the plan to nationalize Fannie was one I believe made in March if not before. Even if the two GSEs refused to buy up the mortgages to provide the necessary liquidity, then so be it. The plan could still be drafted for the conservatorship nationalization as we have seen play out.
The preferred route is a new authority for a bailout similar to the S&L crisis or to the bank liquidator in the Swedish banking crisis of the early 1990s.
You say:
“FYI, my view has been if one must go this course, (and I am not a proponent) the way to do it would be via a new agency. You can’t muddle the mission of bodies dedicated to at least attempting to do reasonably high quality loans with ones in the salvage business. They require different skill sets, and should have different financial structures too.”
No argument here.
As for the political pressure, what I see as persuasive pressure is a threat to re-intensify the call for tighter regulation of Fannie and Freddie. This was a time-consuming mind-numbing nightmare inside of the companies for well on three years. The personal scrutiny was large as well. In the end, Freddie officials did have to cough up a decent amount of money. SEC settlements were for $400,000 for former president David Glenn, $154,227 for former chief financial officer Vaughn Clarke, $136,663 for former senior vice president Nazir Dossani and $99,658 for former senior vice president Robert Dean.
That’s really the only pressure that I mean. Whether that would be enough pressure, I can’t say but your response about Dan Mudd’s not playing ball suggests it’s not enough.
So my theory is no ‘conspiracy theory.’ It is simply electoral year attempts by a lame-duck administration to end-run around a housing bailout. I hope that puts things in a less “second shooter on the grassy knoll” context.
Regulators are whistling past the graveyard (GSEs “adequately capitalized”), but with F&F paying spreads on their debt corresponding to a five-levels-lower credit rating, their business model doesn’t work, any more than Bear Stearn’s did. Simply put, if CONfidence fails, they can’t soldier on.
And how does OFHEO get off saying that $80 billion capital to support $5 trillion in assets and guarantees is “adequate”? Setting capital requirements is arbitrary, but using the 8% guideline applied to banks, shouldn’t F&F have more like $400 billion capital to support their risky business? (Mortgages inherently have much gnarlier trading characteristics than straight bonds, owing to early payoff risk which is impossible to quantify exactly.)
Tragically and predictably, the “too big to fail” doctrine is already being invoked. But why do we need F&F? Within this decade, both companies got their accounting in a twist over derivatives, had to be audited and restate earnings, dumped CEOs, etc. Now the teetering mismanaged behemoths threaten the dollar and the credit rating of USGOV itself. If this is success, I’d sure hate to see what failure looks like. (A question CONgress should ask itself, with its towering nine (9) percent approval rating.)
I have been looking for an iconic bankruptcy to put a period under this twilight interlude of financial distress — a household-name bank or industrial company. Who would have thunk that it might be Freddie Mac? Freddie, we hardly knew ye!
Yves & all,
so many question marks:
Who is shorting F&F equity into the ground?
Why now?
What hand is the administration playing here?
How will Schumer/Dodd play along?
It looks like an attempt from the Bushies to kill F&F in a way that brings a lot of profits to bondholders while killing its stockholders. What is the political benefit of it? Money Funds and Banks would look better, Gov Bonds worse.
COuld there be a deal with the Chinese? The shorting started after G-8.
Chinese support Dollar and T-Bonds, Bush guarantess agency bonds and lets BB raise 25 in automn?
Pre market Friday Fanny -42% her fat little bro Freddie -41% These guy are zeros, Bond holders will get there explicit guarantee. Trillion dollars for bond holders to short these clowns out of bussiness is really was very cheap.
“A hedge fund guy sent me a newsletter which worked through what happens if either of the GSEs is put into custodianship or otherwise bailed out. Gold goes through the roof and the dollar and stock markets plummet. The language was far more extreme than what I just wrote, BTW.”
I’d like to read that personally. I’m looking for some future predictions on this. Could you post it?
A bailout is definitely coming in some shape or form but talk of secret backroom deals ala Bear is just silly. The Fed, Treasury, etc. do not have the authority to arrange a takeover of FNM and FRE and even if they did, there’s no one out there big enough to play the role of a JPM apart from the Federal Government itself.
Those waterfall charts of FNM, FRE, LEH, WB, DSL, WM, FED, ….
This is what happens when easy money and bailout nation becomes the governing philosophy of crony capitalism. Billion dollar bonuses for Wall Street elites, millions of dollars of contributions to politicians of both parties and of course the revolving door between regulators, policy makers and Wall Street. Rubin, Paulson, Easy Al.
Now the biggest cheerleaders for “free market capitalism” and the repeal of Glass-Steagall and “risk adjusted capital” make even the marxist lenninist communists blush as they scream for nationalization, backstops and bailouts of their losing positions. But those billions in bonuses based on fraudulent financial performance – that’s in the Cayman!
Yes, the shoe is on the other foot!
And now Bernanke is extending access to the discount window to both Fannie and Freddie.
Kinda hard to jive such a measure with their managements’ insistence that “we’re adequately capitalized”.