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164 comments on Freddie Mac/Fannie Mae bailout: Guess Who Wins
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164 comments on Freddie Mac/Fannie Mae bailout: Guess Who Wins
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Here is another angle from Calculated Risk
So are preferred shareholders bailed out or no? Hurricane occupied minds want to know....
Bloomberg adds that the warrants on preferred stock will amount to up to $100 billion:
Also, I should add that the new preferred stock will be senior to the existing one, which will not have much of an impact in the first year, but will do so as warrants are exercised - yet another hot potato dumped on the lap of the next administration, as it threatens to wipe out the regional banks that have a lot of capital tied up in there, and the foreign centrla banks that help such securities as Trasury proxies.
Isn't this the first step to monetisation, where no real asset is used apart from debt?
While I'm sure some of the mortgages are good, does anybody really know the number that aren't!!
monetisation - establishing something (e.g. gold or silver) as the legal tender of a country
Jerome wrote,
"Also, I should add that the new preferred stock will be senior to the existing one, which will not have much of an impact in the first year"
What!?
"Fitch has also downgraded FNM and FRE's preferred stock to 'C/RR6' from 'BBB-'. The downgrade of the preferred stock reflects the subordination of the preferred to any Treasury interest and interest payments are unlikely to resume in the foreseeable future. Thus, any recovery is expected to be minimal. "
from
Fitch Affirms Fannie Mae & Freddie Mac's 'AAA' IDR; Lowers Pfd Stock; Sub Debt on Watch Evolving
Last update: 4:28 p.m. EDT Sept. 7, 2008
CHICAGO, Sep 07, 2008 (BUSINESS WIRE)
This is an immediate hit to the market value of the preferred. All financial institutions holding these preferred as part of their capital will take an immediate hit.
****
U.S. watching Macs' preferred shareholders
WASHINGTON, Aug. 23 (UPI) -- U.S. Treasury officials are watching Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE)'s preferred shareholders -- which include many banks -- for signs of panic, sources say.
Citing sources close to the department, The Washington Post said Saturday that Treasury Secretary Henry Paulson is looking to avoid wider financial turmoil by making moves that would prompt the preferred shareholders of the troubled mortgage finance companies to sell their shares.
Paulson is said to be keeping a close watch for any sign of panic among those institutional shareholders as he decides whether to inject government money into the two companies, the Post said.
The value of the shares, estimated to be worth $36 billion, has fallen recently, with Fannie's dropping 26 percent and Freddie's falling 36 percent in the last week.
Analysts say the situation may reach a moment of truth in early September when the two Macs will seek to refinance about $225 billion in mostly short-term loans that are coming due. Any sign of a sell-off by the preferred shareholders will likely persuade Paulson to act to inject the government funds, the newspaper reported.
yes and no. The hit is immediate, because the likelihood of future warrants being exercised is high, but they haven't actually been exercized yet. It's just the diffrerence between an event that has happened, and one that has not, but is highly likely to. Both will get a similar rating, but the event has happened in one case and not yet in the other.
The preferred stock will be widely held within the US, including being held by regional banks (those least affected by sub-prime???). Those banks must now write down their stock holdings.
I don't know if this conservatorship will qualify as nationalisation, but if it does, and I see no reason why not, then it will triger default on any FMFM CDS (credit default swaps).
Previous interventions have had the effect of boosting the stock market for a while, not permanently since there are no real changes to the business practises.
This won't help anyone struggling to meet their mortgage repayments. IMHO it is a bail-out for investors in the bonds most notably the non-US investors who were threatening to dump these bonds.
Where are we going to get the money? Next year fiscal deficit will be about 500 Billion. These guys are nut -- I am sick of passing all the debts to the next generation.
Paulson is helping his friends out in this bailout. Too many bankers are heavily involved with the toxic mess that created the current crisis and yet they got the pat in the back. Sheesh -- what a democrazy we have here.
Democrazy is an apt description, but kakistocracy works as well.
http://en.wiktionary.org/wiki/kakistocracy
"Government under the control of a nation's worst or least-qualified citizens."
If you read past the pin factory in Adam Smith's WEALTH OF NATIONS, he ultimately says that the business class is the least qualified to run the government because they will ultimately tip all of the rules to their own profit. Sounds familiar.
Good point!
And Founding Father Thomas Jefferson believed that farmers were "the most precious part of a state," "the chosen people of God," and the only ones who could be trusted with governance, because they were self-reliant. For Jefferson, landholding and working the land kept a man honest and virtuous. The purpose of farming was not to generate excessive wealth, but to permit a decent independent lifestyle, and government’s role was to protect the freehold farmer. Through technological improvements—and not the slave labor and large farms that characterized commercial agriculture—ordinary men could “escape the tyranny of their social superiors.”[ii]
They're going to borrow the money. This isn't a taxpayer bailout because nobody's talking about raising taxes to pay for it. This is a bailout through inflation so the people who are really paying are savers and holders of U.S. dollars around the world.
Once the government can no longer borrow money from foreign creditors at reasonable interest rates the Federal Reserve will begin to monetize the debt by just creating new money out of thin air. Welcome to the hyperinflationary depression. I think we'll call it The Greater Depression.
This is along the lines I was thinking. The government is "printing" the extra money needed for these banks. Through this additional injection of money into the system I'd expect the dollar to weaken and inflation to continue to increase, unless demand is somehow curtailed at the same rate that money is being created.
It would be helpful to talk in terms most people can understand. So my question is: What does this move do to the purchasing power of an American family with about the median income over the next few months to few years?
no matter whoever takes whatever moves, either the income will be diminished (through the massive unemployment and diminished economic activities brought on by the deflation) or the purchasing power of the income will be diminished (through the inflation).
...hyperinflationary depression.
Yeah, that's what I think. That's two catastrophes at the same time. But you're leaving out one more: war.
Davebygolly,
I know what a balloon going up is like and I know what it is like when it goes down but going both directions at once sort of stretches the imagination. Our pretty balloon has a hole in it and unless hydrogen in equals hydrogen out we can only have a uppy or downy balloon.
Now show me how that equilibrium will come about. Housing down, markets down, big bucket bailouts, ... Could be this moon but while I think the guys got the sentiment right thier direction is 180 off. I think they hadn't quite got the last of this out of their imagination.
You have to wonder why Japan and other nations have lent us so much money, already. There has to be a hidden political element to this.
In the case of Japan, maybe it's that we have our mitts on the oil spigot, and so they have to settle for a crappy return and ultimately take a currency loss.
Of certain oil producing nations, we protect their rulers and they buy our Treasuries, knowing that they must never, ever cash them in.
Hyperinflationary depression...exactly. John Williams called it back in April and so far it looks like he's been right on the money: Shadow Government Statistics HYPERINFLATION SPECIAL REPORT
Just for context the Japanese National debt is around 188% of GNP, and their population is due to age rapidly and fall.
I haven't got a clue how that compares to the various off-budget items and so on in the US, or what the off-budget items are for the Japanese.
When they had their crash in the early 90's they spent huge sums on public works programs, with perfectly smooth roads to nowhere.
What the heck is going on, and who is more broke than who I have no idea - but I suppose that is the point for those carrying out the shell game.
Dave, One also needs to consider unfunded liabilities when looking at a country. Americans have 5 times the amount of federal government unfunded liabilities than we have in federal government debts. Financial models that do not consider the growth-stunting effects of Peak Oil already show huge financial problems developing due to an aging population and unfunded entitlements. Former US Comptroller David Walker likens this problem to a fiscal cancer.
I laugh at McCain and Obama trying hard to get elected because either one of them is going to see this problem grow much larger on their watch as the Baby Boomers start to retire. Whoever gets elected is therefore going to be unpopular.
Yeah, but a lot of those unfunded liabilities will simply not be honoured - this is particularly true for intergenerational transfers.
Most of the liabilities for pensions and health care will either be inflated away to nothing or defaulted on.
International obligations are more difficult, or your credit rating goes, but Gramps may find himself with a much reduced life expectancy.
The size of the debt is a large problem but there's one that compounds that problem. The largest problem that NOBODY talks about is HOW WE FINANCE THE NATIONAL DEBT. The average maturity of the national debt is about three years. That means we have to repay half of the debt every three years by refinancing it with new debt. (Balance transferring from one credit card to another.)
If this was like the 1970's when the national debt was financed with 30 year bonds there wouldn't be so much need to worry. Just like if your home has a 30-year fixed rate you don't care how high rates go, you don't need to refinance. But if you were required to refinance your home every three years you'd be in deep trouble.
The current debt is almost 10 trillion dollars. (This doesn't include unfunded liabilities which is another HUGE problem I won't go into.) If the average interest rate paid is 3% the annual interest cost is $300 billion. If short term rates rise to 9%, then three years later (after refinancing half the debt) the average interest rate will be 6% therefore doubling the interest paid to $600 billion dollars per year. That's the MOST IMMEDIATE FED GOV FINANCIAL EMERGENCY IMHO.
It's worse than that. There is a short-term finance crisis as well as long-term.
Ronnie Reagan financed the arms expansion by issuing 30 year bonds.
For the last Iraq war the finance came, in an act of genius, by the issuance of 10 year bonds.
So of course they all mature within the next few years, creating a huge spike in financing.
I did not bother keeping the reference, as we are screwed anyway, but 09, 10, 11 and 12 are the years they mostly mature from memory.
Congress voted in July to raise the national debt ceiling by 800 billion dollars to 10.6 trillion basically to pave the way for Paulson to do this.
http://wedeclare.wordpress.com/2008/07/24/must-we-die-before-this-stops/
So those foreign countries which buy up our debt will finance it for us until our great grand kids pay it off. China loves to buy our debt, The bank of China is the top foreign preferred stock holder...
http://www.marketwatch.com/news/story/chinese-government-top-foreign-hol...
So we're borrowing from them to pay them... among others...
Based upon information available, preferred stock owners are not beng bailed out - but they may sustain huge losses, as their shares are now subordinate to US government shares. The bill passed by Congress didn't allow a preferred stock bailout, and I frankly couldn't understand why at late as yesterday the WSJ said they still may be bailed out.
Paulson seeks to provide some type of help to those banks left holding the bag from going under, which means many banks may suddenly find themselves in a position of having to sell more stock soon.
In practice, given the warrant structure used, that question will really be decided by the next administration. The structure is in place to wipe out other preferred stockholders (as they will fall behind up to $100 billion of new senior preferred stock), but right now it's not yet happening as only $1 billion has effectively been put in place.
This is about kicking the can further down the road - to the next administration, and at least to beyond November.
You are, of course, correct.
Since the concept of conservatorship does not follow conventional accounting rules, it's not clear if those accounting rules for bankrupt companies would apply. If they did, F & F would have to realize huge losses for assets such as tax credits which no longer have value, and it would also have to write off other assets that are similarly worth less - or worthless.
Although they could kick the writeoff can down the road until just after the end of third, these losses will be coming. To put it bluntly, preferred stock will eventually have no value (unless Congress intervienes) - but meanwhile holders will still be able to sell the shares for something
Like all the other Fed/Treasury bailout gigs of the past year, this is radioactive with Moral Hazard. Expedient today, tomorrow will take care of itself. At some perspective, cynicism and desperation start to merge together.
As usual, the bell rings on a weekend.
What passes for strategy in the Bernanke/Paulson cadre is the HOPE things will get better all by themselves. All this bailout can possibly accomplish is to buy some time (at enormous cost).
Will the government guarantee the mortgages that underlie all the questionable securities? Why doesn't the Treasury write all Americans ten-million dollar checks so we can run out and buy Ferraris?
Time is not the issue. The real issue is whether the distributed risk financial model that Fannie and Freddie used has any relevance. Even in the best of times (low interest rates) the GSE's struggled. See Paul Volcker's remarks:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aw4J8Ty2h3fE
An even bigger issue is whether the suburbia-sprawl paradigm that Fannie and Freddie supported for so long is viable in a Peak Oil environment. If suburbia is 'DOA' then capital needs to be conserved for constructing a replacement. The expensive support of a useless shell is pointless, but in the modern world the appearance of a thing is more important than the thing itself.
Without the distributed risk financial model, the reason for the GSE's existence vanishes. This GSE's product has been tested in the (stock) marketplace; Fannie and Freddie could not raise capital. Precipitating this crisis was their near worthlessness on the equity markets. Their capital bases are lies. The People (the one's who matter, those who 'invest') have spoken.
http://www.nytimes.com/2008/09/07/business/07fannie.html?_r=1&ref=busine...
They've cleared a market. It's doubtful this will translate into a recovery of the larger market for securiized instruments. Why? Because the Treasury is on both sides of the deal! The sock puppet on the left hand sez, "We'll buy all this so-called toxic waste from you guys!" and the sock puppet on the right sez, "We now own both enterprises so we'll be happy to sell to you!"
Good Grief!
On the plus side, the Conservatorship will replace large numbers of overpaid knuckleheads with civil servants who will do the same job for far less. An aftershock will be felt in Northern Virginia where many of the GSE management bought or built enormous McMansions and stuffed the garages with Hummers and BMW's. I expect an effect on the local real estate market.
Simply liquidating the companies and recreating any number of viable successor businesses out of the ruins would have made more sense. As it stands, the Fannie and Freddie Zombies will be hanging aronnd taxpayers' necks, bleeding money for years and years to come.
The current regime seems to feel 'Creative Destruction' is an unnecesary burden to be avoided at all costs. It will be interesting to see how this plays out. It seems hardly likely that the Fed/Treasury Duo has the bsse money available to socialize any more private companies. From this point onward, what Americans and their overseas creditors will see is the printing press. Welcome to the Weimar Republic.
You said it-and this is just the appetizer.
I suppose to the extent that they are thinking long term, their plan (hope) is that they can patch things together until circumstances improve (or until someone else is in office), but what if we continue to see an accelerating decline rate in the volume of exported oil worldwide?
In any case, even the deflationists concede that the end point is hyperinflation, after foreign creditors pretty much stop lending money to the federal government. Aren't we headed that way at rapid speed? And won't the buyer of last reort be the Fed, i.e., massive monetization of federal debt?
The first rule of real estate is to sell your problems to somebody else. This is the Fed's/Treasury's strategy. They hope circumstances will improve without having any clue what the improved circumstances would be ... or how to get there.
This is a Homer Simpson problem. Oil export issues complicate matters; a number of geopolitical 'situations' can turn into affairs with little upside but budget- annihilating risk.
Of that, I am not so sure. There are limits to monetization. Someone has to accept the tranactions at face value for monetization to work. In other words, monetization is a loan, nobody can compel another to borrow. Monetization works (cough, cough) in Zimbabwe because the citizens of that fine country don't have alternatives to the local currency, nor can they express displeasure to their government. We canny capitalists in the west have many alternatives and many feedback loops available. People recognize debasement when they see it. There are limits. This is why I believe the Fet/Treasury is at the end of the line for 'bailouts'. An expansion of base money would be felt in the bond market. Rates would jump. Since the Federal Government borrows hundreds of billions (and is set to borrow another half-trillion this year) that jump in rates would be prohibitive.
Some derivates markets are too large even for the combined resources of the world's major economies together to bail out. The CDS market comes to mind; I don't think the Fed would even try. They would work around the edges like they did with Bear Stearns. I think if the CDS market were to implode ... the end point might be a new US currency. We would devalue, of course. Even though this would be 'inflationary' on the surface, there would be a lot less of the new money (the Obama?) in circulation the effect would be deflationary. If people hoarded - not trusting financial institutions - the outcome would be depressionary. This would be the case ... even if the Treasury printed its head off! The Treasury would lend the money to banks ... that nobody in their right mind would go into. The banks would go broke waiting for people to come in and ask to borrow.
In fact, if things got to that point, the public would not be able to borrow, anyway! Nobody would be creditworthy above what capital they already possessed; if they had a hundred Obamas, they could borrow a hundred, provided they give their hundred to the bank as collateral. This is what happened in the 1930's, all across the country.
Since all modern money is credit, I tend to lean toward deflation. A lot of money/credit is being created by the Fed/Treasury ... it goes to banks, thence to hedge funds, finance companies and commercial banks ... where it disappears. For instance, capital that is being raised by finance companies is being used for 'balance sheet' purposes. This is money thrown into the furnace. Credit is being destroyed on Wall Street -and NYMEX and in the Bond Market and on currency spot and swap markets and in real estate- faster than it is being created. Evidence of this is the decline in asset prices across the board; real estate, stocks, oil, gold ... some of the loss is actual. Ask a sheik how much less his oil is worth today compared to a couple of months ago. More of the loss is in the collateral value; the money/credit that could be created from that collateral that could be used to generate more money/credit. Here is a general tightening of credit. Easy money/credit inflated the values of these asset classes, now the reverse is happening.
The 'Niewe Deadbeats' are on their own. It will interesting to see what happens when the next 'too big to fail' institution ... fails. Who will it be? GM? Amerian Airlines? Citigroup? Merrill Lynch?
A sign to look for is when Americans start accepting other currencies. The 'Gold Bugs' are already out of the woodwork, never a good sign ....
I agree Steve. Creating liquidity when confidence is gone is a non-starter. As you say, any money created disappears into a black hole where it is hoarded, as banks are already doing, even before circumstances really deteriorate.
I see the bailout of Fannie and Freddie as a desperate double-or-nothing attempt to reflate a rapidly deflating bubble. As such it is doomed to fail. Hank Pualson said that if he carried a bazooka in his pocket then he wouldn't have to use it, but the market called his bluff. Now he's taken it out and is conspicuously waving it around, but I think he's still bluffing. He's hoping that if he can reduce transparency far enough, while loudly talking up his intentions to stand behind the mortgage market, then confidence will eventually return and a crash will be averted, avoiding the need to spend the sums he has promised. Personally, I think the market will call his bluff again.
You are right that no one has deep enough pockets to bail out the derivatives market, and a meltdown in the CDS market is inevitable IMO. Counterparty risk is huge and growing, and the coming firesale of assets will reveal the extent of that risk. Whatever central bankers or treasury officials do is likely to be overtaken by events they cannot control.
I am a deflationist, as readers know. If we do eventually end up with hyperinflation, it don't expect it to be for a very long time. Deflation supports depression and depression supports deflation in a vicious circle of positive feedback. This dynamic will be self-sustaining for a long time - my guess is at least 10 years, if not longer. That fact that it will be global makes it likely to last even longer.
For as long as we have a bond market, and an addiction to international debt financing, any serious attempt to inflate (even one doomed to fail anyway) would be met by sharply higher interest rates. Government action can really only make things worse at this point.
I never understood this part of the deflationist argument (which I understand is the core one).
First how can increase in money supply lead to more expensive credit? At least in the short term the opposite should be the result. The only way it could result in higher rates would be after the extra cache has been absorbed by the economy, resulting in higher nominal prices, only then the investors may demand higher returns on their bonds. But all of this takes time and all of this assumes full transparency of the money supply, reliability of the reported CPI, honest government.... how many of these assumptions take hold?
The bottom line: IMO it is true that the US gov will not hyperinflate. But it will definitely try to inflate - meaning the press will be working only as much as it can without anyone "noticing". In this context the supposedly doomed delaying tactics for saving the overleveraged credit markets make absolutely different sense. In the end it will still be inflation taking care of the credit bubble, though it will not be with a "Bang!" but more like a "Psssst..."
what's the definition of liquidity? money circulation? what's the confidence about? money or tangible assets? if the confidence in a fiat money is gone, what will happen to the liquidity? will the money circulation slow down, stop or speed up?
how can an international debt financing market go on for that long when the whole world is in a deflationary depression?
Easy. They still had positions to close out.
The financial press is there to talk their book, not to provide information.