Subscribe to this blog's feedNaturally, there is far more being written today about the Fannie and Freddie bailout than anyone can assimilate, but a few points:
what's going to happen to GSE shareholders? Paulson's speech includes the warning:
"The federal banking agencies are assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac. The agencies believe that, while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital. The agencies encourage depository institutions to contact their primary federal regulator if they believe that losses on their holdings of Fannie Mae or Freddie Mac common or preferred shares, whether realized or unrealized, are likely to reduce their regulatory capital below "well capitalized."
Can we get a bit more detail on that? Probably not - OTS is looking into it, and estimated that 2% of thrifts had GSE shareholdings equivalent to 10% or more of Tier One capital.
Normally, of course, banks wouldn't be allowed to hold unlimited amounts of equity as capital; but GSEs were regarded as special. Weren't they just.
Yves Smith points out the damage this could do - estimating that it could cut banks' lending ability by $180 billion. (And adds her surprise that both common and preferred shareholders are being almost wiped out.)
And then there are the CDS to worry about. Alea reckons that the bailout (sorry, conservatorship) probably counts as a triggering event; but these two articles from last month disagree, pointing out that GSE debt is written to be a bit more flexible. Payments could be suspended for up to five years (FIVE YEARS?) without triggering a default.
Here's an earlier post about the CDS spread on GSEs.
Big picture: economist Brad Setser writes "I suspect this is the first case where foreign central banks exercised their leverage as creditors to push the US government to make a policy decision that protected their interests..."
Quite possibly. Foreign central banks have been shifting towards treasuries rather than agencies in the last few months for exactly this reason. There's also the point that a lot of of the debt is being held by US institutions, who are every bit as able to put pressure on the Treasury to save their bacon.
Bottom line: the Treasury has committed to buying lots of MBS from the GSEs; the GSEs, meanwhile, are going to keep increasing their MBS holdings until the end of next year, and then taper them down at 10% a year to an unspecified sustainable level.
Which means taking on $300 billion losses, reckons William Poole, ex of the St Louis Fed.
Personal take: there is, once again, a John Vann connection. The nonsense that was the GSE setup dates back to when the US government decided to turn a government agency into a sort-of-government-guaranteed but publicly traded private sector company. The result was a company that exploited an implicit government guarantee to make profits for its shareholders, and went outside the original intent of its founders to grow very aggressively in the US mortgage market. Why did this sort-of-not-really privatisation take place? Because it was 1968, and the Vietnam War was putting immense pressure on the federal budget - moving Fannie Mae's liabilities off balance sheet would hide them. (Hiding your embarrassing debts in an off balance sheet entity with a silly name? Sounds familiar.) Creating a second GSE, Freddie Mac, two years later, was supposed to keep the market competitive; in fact, the two unsupervised GSEs seem to have operated as a duopoly. And, as a result, seven more years of war spending seemed slightly more fiscally sustainable.
In their proper historical context, Fannie Mae and Freddie Mac aren't just financial embarrassments - they're the final legacy of the best and the brightest, the very last of the Bright Shining Lies.
