Fannie and Freddie: We All Support You (Even if We Don’t Support That Decision!)
1. Fannie and Freddie are not created equal (no one “in the know” ever thought they were…). Apparently Freddie is under-capitalized and Fannie is still smelling the flowers on their way to being under-capitalized (from the NYT article):
Then, last week, advisers from Morgan Stanley hired by the Treasury Department to scrutinize the companies came to a troubling conclusion: Freddie Mac’s capital position was worse than initially imagined…
While Freddie Mac’s accounting woes make it easier for regulators to force the company into conservatorship, there was more resistance from Fannie Mae, according to people familiar with the discussions. Once the government took action against Freddie Mac, however, confidence in Fannie Mae would certainly waver. Given Fannie Mae’s declining financial condition, the company has few options but to concede to the government’s demands.
Fannie Mae is resisting?
2. Taxpayers are about to own a whole lot of crap. Of course I already noted the large amount of non-prime mortgages sitting on the G.S.E.’s books (and the poor credit metrics)… But, apparently, the marking to market of these securities isn’t hurting their capital position. Oh, holdon, stop celebrating–it’s because they don’t mark the portfolio. Here ya go (from the NYT article):
Freddie Mac’s portfolio contains many securities backed by subprime loans, made to the riskiest borrowers, and alt-A loans, one step up on the risk ladder, the company has not written down the value of many of those loans to reflect current market prices.
Executives have said that they intend to hold the loans to maturity, meaning they will be worth more, and they need not write down their value. But other financial institutions have written down similar securities, to comply with “mark-to-market” accounting rules. Freddie Mac holds roughly twice as many of those securities as Fannie Mae.
3. It also seems that complaints from foreigners are causing the Treasury to take these steps:
The proposal to place both companies, which own or back $5.3 trillion in mortgages, into a government-run conservatorship also grew out of deep concern among foreign investors that the companies’ debt might not be repaid. Falling home prices, which are expected to lead to more defaults among the mortgages held or guaranteed by Fannie and Freddie, contributed to the urgency, regulators said.
Investors who own the companies’ common and preferred stock will suffer. Holders of debt, including many foreign central banks, are expected to receive government backing. Top executives of both companies will be pushed out, according to those briefed on the plan.
Now, let me make a point here: The decision to back only debt and not preferreds and common stock is completely arbitrary.
Let’s fly off on a tangent and ask ourselves what would happen if government backing of the debt occurred as a singular event–nothing else happened. Well, then, the guarantee that everyone thought was in place would be in place. The market, credit conditions, and the housing market would most likely wipe out equity anyway. So, then, why does the government need to do this explicitly? Just take over day-to-day operations… They are regulated entities, it’s not a stretch to strike a deal where the regulator ousts management and takes over!
Making this guarantee explicit, by the way, will also make holders a hefty profit as spreads will undoubtedly rally for agency debt–a nice gift to foreign holders of this debt at the expense of the shareholders current financial holdings, it seems.
4. I would look for a very, very serious revisiting of a lot of transactions. This would clearly be very controversial, but if I were advising regulators and the government, I would start taking a strict view of the G.S.E.’s charters, and unwinding whatever I could. No way the G.S.E.’s should have ever owned subprime loans or bonds. I also have a feeling that there are clauses that allow for some kind of “regulatory put” on many transactions if deemed outside the G.S.E.’s authority or charter. Will the government go through these? Maybe. Truth be told, they need to de-lever these behemoths and raise capital cushions somehow.
Did you catch Bill Gross on CNBC just now? They asked if he had been approached by the Treasury about any government-led solution, presumably asking if PIMCO would participate. Gross said he couldn’t comment, which means the answer is yes.
Okay… now about an hour until the details are confirmed. We’ll see what happens.