Tuesday, September 9, 2008

Ins and Outs of the Fannie Mae-Freddie Mac Bailout


Foreign Governments Holding Fannie and Freddie Debt.
Large amounts of Fannie and Fred debt are held by foreign central banks. A collapse in the value of this debt would not only have financial consequences, but foreign policy consequences as well. With all the foreign policy problems the Bush Administration has right now, it doesn't need Fannie and Freddie to muddy the waters even more. These foreign governments and other foreign investors provide much of the financing for the U.S. government and the U.S. economy. Leaving them with big Fannie and Freddie losses would make them feel like they made a bad bet, which would have a detrimental effect on foreign relations.

Other Debtholders. All the mutual funds, pension funds and other investors holding Fannie and Freddie debt are sitting pretty, with explicit federal guarantees now bailing them out of market risks. Uncle Sam is the richest uncle of all, and it's nice to have him helping you out.

Republicans. With the housing market still headed downward, and credit remaining badly crunched, the Fan/Fred situation would only have gotten worse as Election Day approached. By stepping in now, the Bush Administration provides some short term stability and takes ammunition away from the Democrats. The long term problems will be left for the next President and future Congresses. The nationalization of Fannie and Freddie make sense for a lame duck administration that would find redemption in the election of Republican successors.


Common Stockholders. In a corporate reorganization or liquidation scenario (it could be either with Fannie and Freddie), common stockholders are last in line to be paid out. Lots of luck, folks. You got the biggest returns when times were flush and you get coal in the stocking when times are tough.

Preferred Stockholders. Preferred stockholders are next to last to be paid out, and there's a lot of low-priced Fannie and Freddie preferred stock for sale in the market today. Be cautious about buying it. A low price may not be a bargain. The government has suspended Fannie's and Freddie's dividend payments, so the preferred is a pure speculation and the odds may be rather bad.

Top Management. The highest ranking executives at Fannie and Freddie lost their jobs. It remains unclear whether they should be tarred and feathered before being booted out of town. But they weren't fixing the problems, and that's what management should do regardless of who is responsible for the problems.

Lobbyists. A vast herd of lobbyists on the Fannie and Freddie payrolls are weeping at the news that the federally controlled Fannie and Freddie will not engage in any lobbying activities. This is perhaps the best decision made by Secretary Paulson and his colleagues in connection with the federal takeover. Fannie and Freddie have, for decades, deployed lobbyists to suppress almost all efforts to reform the way they operate. Rarely has any interest group fed so gluttonously at the public trough as have Fannie and Freddie. Fannie and Freddie have used political power and the implicit/explicit federal guarantee of their obligations to insulate themselves from market forces. Thus, they didn't have effective risk management, because they didn't think they had to face risk. By putting a stop to the lobbying, the government has an opportunity to evaluate and address Fannie's and Freddie's problems with greater objectivity.

Democrats. While both parties have much blame to bear in connection with Fannie's and Freddie's problems, the Democrats deserve the greater share. They have, while accepting generous campaign contributions from Fannie, Freddie and their running dogs, blocked legislation that would have converted these entities into true market-based entities. Then, Fan and Fred might have been forced to institute effective risk management processes. Had they had real risk management, we wouldn't be where we are today. The Democrats have lost the political power Fannie and Freddie wielded.

Fannie and Freddie. Fannie and Freddie as they now exist are among the biggest losers. They will either be reformed or dismantled. They won't continue business as before. All the better, since business as before will cost taxpayers a mountain of money at a time when the federal deficit is metastacizing. It would be best to put Fannie and Freddie down. News reports indicate that they continue to engage in potentially questionnable accounting. Does anyone know how much unrealized loss Fannie and Freddie still face? They should be liquidated, like the bad S&L's from the 1980s. In their place, the FHA and Ginnie Mae, which make explicit federal guarantees, can be given expanded roles. Or a new federal housing finance agency with a clean balance sheet can be created. It, like the FHA and Ginnie Mae, should provide an explicit guarantee of the mortgage. When federal agencies make explicit guarantees, they maintain meaningful credit standards--no loans for those with no incomes, assets or discernible employment. Thus, they should spend much less time reaching for the taxpayers' wallets.

Sister Kisses: There are also those who receive kisses from their sisters in connection with the federal takeover of Fannie and Freddie.

Home Buyers. The nationalization of Fannie and Freddie will probably lead to a small dip in mortgage rates. But credit standards will remain high: you'll still need a real downpayment, verifiable income and assets, and a decent credit history. And fees for federally guaranteed loans will put a dent in your cash balance. Large numbers of the buyers at the late stages of the real estate boom didn't meet these standards and they won't be able to get loans now. So, if you're a good credit risk, you may get a slightly better deal on your mortgage. Otherwise, little has changed.

Home Sellers. The late stages of the real estate boom produced extreme prices that many home sellers still think they can get. Those prices, however, were made possible only by a flood of really stupid mortgage loans to borrowers who had no identifiable ability to repay. The nationalization of Fannie and Freddie will not bring about a renewal of stupid lending, and extreme prices won't be paid in the foreseeable future. Housing prices will probably continue their overall decline until who knows when.

U.S. Economy. The federal takeover of Fannie and Freddie may slow the decline in the real estate market. But it won't produce a resurgence. At the same time, the cost of the bailout will increase the federal deficit and could exert upward pressure on interest rates as the federal government borrows more to pay out Fannie and Freddie debtholders. The nationalization of Fannie and Freddie staved off panic in the debt markets. But it won't do much to revive the economy.

Crime News: We are glad to report that a stolen mechanical gorilla has been found. http://www.wtop.com/?nid=456&sid=1471349.

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