Early details on the Fannie Freddie bailout

There's more links in the original URL
http://bigpicture.typepad.com/comments/2008/09/fannie-freddi-1.html

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). 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.

More on the bailout to come . . .

 

Roubini:
This bailout plan has features that exacerbate the moral hazard of this government intervention and the overall fiscal costs of such intervention. Specifically:
1) common shareholders instead of being fully wiped out will only be diluted and hold about 20% ownership of the GSEs.
2) we estimated in June that the eventual losses for the government from this bailout could be as high as $200 to $300 billion (i.e. 5% ultimate losses in view of mostly prime portfolio,) an estimate that is now shared by former Fed Governor William Poole.
3) the current preferred shareholders will not be fully wiped out.
4) the subordinated debt holders and the unsecured debt holder will not be subject to a haircut--> government preferred shares are junior to debtholders.
5) while not hitting the unsecured debt holders may have made some sense (large foreign holdings), not touching the subordinated debt of the GSE makes no sense.
6) as argued before, other than nationalization, the proper way to recapitalize F&F was to convert part of the agency debt into equity. -->see overview of long-term solutions.
7) the government plan includes the provision of unspecified credit lines to Fannie and Freddie and to the other 12 FHLBs. Since this provision of credit is a form of debtor in possession financing – like IMF lending to countries under distress – it should be de jure senior to the debt issued by the GSEs; it should also be senior to the mortgage claims that the GSEs have guaranteed. Treasury is silent about that.
8) purchase of mortgage-backed debt issued by the GSEs in the open market is another form of government intervention and manipulation of the MBS market that is totally unwarranted.
9) the short term increase in the portfolio of the GSEs is reckless and a further waste of taxpayers’ money.
10) This plan does nothing to restore the long term viability and efficiency of such institutions. It is just a very expensive taxpayers’ funded bailout of the shareholders and creditors of these institutions.