Want to get a good (and opinionated, but I like opinionated) summary of how Fannie and Freddie got into their current mess and what's likely to happen? First, be sure to check out Lou Barnes' latest edition of Mortgage Credit News:
The Fannie-Freddie story will be widely mis-reported, especially in those journals hostile to housing or to any intervention by government into markets.
The real story is a tale of public policy mangled by everybody connected to the two Agencies in the last 15 years -- both parties, two Administrations, eight Congresses, and real estate- and mortgage-industry lobbying...
The real story is very good news. Fannie and Freddie have high-quality portfolios, the only trash the “affordables” forced on them by Congress. A government takeover would wipe out stockholders, but might not cost a dime. Then the original charters will be restored: upon return of good times, both outfits will gradually sell their portfolios....
I have believed since August that a nouveau Resolution Trust Corp would be required to extract the worst of the assets, take stock in the institutions, and work out the trash over a long time. That extraction will work (we’ve done it many times), but I’m a tad nervous that we waited too long, damage from credit starvation now may be hard to stop, especially in housing.
Some good news: the same Congresspersons who insisted all fall and winter, “No bailouts! Punish the lenders!”, by this weekend began a different chorus. “Necessary evil... Regrettable but unavoidable.” About time, guys; and I hope in time.
To me, the knee-jerk 'no bail-out' crowd never seemed the grasp how intertwined the mortgage crisis is to the overall economy. After all, why learn about how the world works when you can simply shout out platitudes instead (you know, like the politicians!).
So where are we at now with the two mortgage giants? The Wall Street Journal summarizes in this article:
The government headed into the weekend deliberating the state of struggling mortgage giants Fannie Mae and Freddie Mac, with Treasury Secretary Henry Paulson insisting that any potential rescue plan not benefit the companies' shareholders, according to people familiar with the matter...
The discussions at Treasury highlight the dilemma created by the financial crisis gripping the U.S: Some institutions are considered too big to fail, but propping them up could erode the market's incentive to properly judge risk by offering investors a false sense of security.
After a week of near panic among shareholders of the two companies -- and a stomach-churning day on Wall Street Friday -- the next big test will come Monday when Freddie Mac is due to sell $3 billion of short-term debt. An unsuccessful sale could be a major blow to investor confidence. If the administration were to intervene, it could do so before markets opened that day, according to a person familiar with the deliberations...
How any rescue might be orchestrated remains unclear. The administration doesn't expect the firms to fail and it is "not talking about nationalizing" the struggling mortgage giants, according to a person familiar with its thinking. Mr. Paulson issued a written statement Friday saying that the administration's "primary focus is supporting Fannie Mae and Freddie Mac in their current form."
One possible option would have the government buy a chunk of Fannie and Freddie's preferred stock with terms that dilute the equity of common shareholders. The Federal Reserve could support Fannie Mae or Freddie Mac in a short-term funding crisis through its lending operations, which were extended to investment banks in March with the downfall of Bear Stearns Cos. A spokeswoman said Friday the Fed hasn't discussed that possibility with either company...
Investors are worried the firms will suffer more losses as mortgage defaults rise. Stock-market investors are also worried the companies will need to raise significant amounts of capital to cover those losses. For investors, that means the value of their ownership stakes in the company will be cut. Bond investors continue to lend to both companies, though they are also demanding slightly higher interest rates.
If a rescue becomes necessary, Mr. Paulson does not want to help the shareholders because of the "moral hazard" it would create -- desensitizing investors to risk because they believe the government will bail them out. It's a similar position he took during the government-orchestrated rescue of Bear Stearns by J.P. Morgan Chase & Co...
The crisis has been exacerbated by the strange hybrid nature of the two companies, which have prospered because they are seen as having the implicit backing of the U.S. government. Chartered by Congress to ensure a steady flow of money into housing finance, they can borrow cheaply because investors believe the government probably would rescue them in a crisis. Yet they are owned by private shareholders who want profit growth and dividends.
The implicit guarantee has allowed the companies to borrow at lower rates and buy more mortgages, providing a benefit to shareholders. There's a belief among many politicians and officials that it is the shareholders -- not taxpayers -- who should bear those risks because they benefited greatly in the past from the implied government backing.
The government has increasingly leaned on the so-called government-sponsored enterprises to provide stability to a housing market crippled by falling home prices and banks too nervous to lend...
"Do a little examination and ask yourself, 'What do you think the housing market in the U.S. would look like without the GSEs now?"' Richard Syron, Freddie's chairman and chief executive, said earlier this year.
The Bush administration has long worried about the systemic risk posed by the companies. The administration has pushed for a regulatory revamp, including a new, more powerful regulator to oversee them. Long-awaited legislation that would do that passed the Senate on Friday.
So how exactly do these two mortgage giants work and what would be the consequences of a bailout? A slideshow from the New York Times helps explain.
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