Fannie Mae has the luxury of marking its accounts more accurately because they have no fear of being nationalized or going bust since they already have hit the wall.  So, when we read the latest quarterly results from Fannie Mae, we are not just seeing a glimpse of Fannie’s reckless financing, but of the American financial system as a whole.

From Fannie Mae’s Q2 press release (note the emphasis added):

Fannie Mae… reported a loss of $14.8 billion, or ($2.67) per diluted share, in the second quarter of 2009, compared with a loss of $23.2 billion, or ($4.09) per diluted share, in the first quarter of 2009. Second-quarter results were driven primarily by $18.8 billion of credit-related expenses, reflecting the ongoing impact of adverse conditions in the housing market, as well as the economic recession and rising unemployment. Credit-related expenses were partially offset by fair value gains. The company also reported a substantial decrease in impairment losses on investment securities, which was due in part to the adoption of new accounting guidance…

Combined loss reserves were $55.1 billion on June 30, 2009, up from $41.7 billion on March 31, 2009, and $24.8 billion on December 31, 2008. The combined loss reserves were 1.80 percent of our guaranty book of business on June 30, 2009, compared with 1.38 percent on March 31, 2009, and 0.83 percent on December 31, 2008.

Translation: we lost over $40 billion and our loss reserve rate has more than doubled in 6 months.  We are a financial bottomless pit.

How about this statement on page three:

Total nonperforming loans in our guaranty book of business were $171.0 billion on June 30, 2009, compared with $144.9 billion on March 31, 2009, and $119.2 billion on December 31, 2008.

That’s $171.0 billion in NPLs, not million.  Breathtaking.  Needless to say, Fannie has its hands out for more taxpayer money – $10.7 billion to cover their net worth deficit from this quarter alone to be exact.

But, the reported net worth deficit of $10.6 billion does not represent figures according to fair value. That is covered on page six (emphasis added):

Our estimated fair value net asset deficit was $102.0 billion as of June 30, 2009, compared with $110.3 billion as of March 31, 2009.

Is Fannie far worse off than, say, Citi or BofA, or are they reporting their numbers somewhat closer to mark-to-market? The scale of the losses seem astronomical.

More here.

Related posts:

• Question: How is Fannie Mae a AAA company?
• BofA carrying loans on books for $44 billion above fair value
• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds
• Everyone’s talking about Fannie and Freddie
• RBS reports a record loss of 24 billion pounds

Let’s say you’re an American named Maria living in Southern California.  The year is 2006.  You make $45,000 and your husband David makes another $40,000.  You have two children aged six and four and your two-bedroom apartment is getting too small.  So you decide to consider buying a house.  Eventually, you and your husband find a new home. Now, granted you know nothing about mortgage finance.  But, your guy at New Century Financial hooks you up and with the help of a teaser-rate adjustable rate-mortgage you are able to afford the home.  In the end, you shop around and get another bank you consider more reputable to match New Century’s terms. Sale Price $390,000.  As you have no money down and roll up some fees into the mortgage, the final mortgage price is $390,000 with a second piggy back mortgage of $10,000 for a grand total of $400,000 of debt.

Fast forward to 2009. The economy is in tatters but you and your husband have your jobs. You’re doing alright. And, as it turns out, you have picked wisely by buying the smallest house on the block in a really up-and-coming neighborhood.  The only problem is that house prices in your metro area are down 40%.  Your house, while down less, is still down 20% and is only worth $320,000. This is a big worry because your mortgage was a 3-year ARM and the rate is about to go way up.

Enter the federal government’s “Making Home Affordable” plan.  Just the other day HUD Secretary Shaun Donovan announced that mortgages owned or guaranteed by Freddie Mac and Fannie Mae can be refinanced up to – get this – 125% loan-to-value.  That means, you can take out a refinance loan on your house now valued at $320,000 for up to $400,000. Bingo!  That’s exactly what you need to keep your house.  Do you do it?

Debtor’s Prison

If you do go ahead, we might as well stick you in the King’s Bench because you are about to find yourself in debtor’s prison.  The Blog Seattle Bubble has this nailed (with some nifty charts to boot):

Let’s take a look at some hypothetical home borrowers who currently owe $400,000 in various mortgages with difficult terms or high rates, and whose home is presently worth $320,000. They jump on the new FHFA Home Affordable Refinance Program and refinance into a single 30-year fixed-rate loan at a 5.75% interest rate with a 125% loan-to-value ratio…

With the home value appreciation tweaked to a slightly less rosy scenario, it takes 17 years before our couple can break even selling their house.

Nice, huh?  Their comment on this is dead on:

If the goal of this new 125% loan-to-value program is to financially imprison people in their current homes for a decade or more, then it looks like it could be a rousing success. However, I’m not sure how many currently struggling home borrowers would really consider that to be much of a “help.”

I have a post from last year describing circumstances in Japan that are eerily similar. Take a look.  It’s called “A cautionary tale: story from 1994 Japan.”

Predatory Lending?

I have another angle too.  You’ll notice I mentioned Maria is no financial wizard.  She probably does not appreciate the intricacies of mortgage finance.  Here are two points to consider.

1. In the state of California, you can just walk away because first mortgages on primary residences are non-recourse.  That means that the mortgage is only secured against the house you have bought.
2. However, in the state of California, refinance mortgages are recourse loans.  What does that mean?  It means you are on the hook for that loan.  You cannot just walk away.  The bank can come after you and take your car and the stocks in your E-Trade account. They can garnish your wages. They can even take your clothes and the shirt off your back, literally.  The only thing they can’t touch is your 401-K.  But it’s down 40% anyway.

Why would you trade a non-recourse loan from which you can walk away for a recourse loan that guarantees you’ll end up as bad as some poor slob at Tappahannock?  It doesn’t seem like an incredibly appealing choice, does it?

But, of course, this is a classic case of asymmetric information because you don’t know that you are getting a poor trade, but your bank and the government do.  In fact, the bank makes more money this way because of incentives it receives for refinancing these loans – incentives, I  might add that come straight from the taxpayer to the bank via the Federal Government (see my post “How refinancing helps the likes of Bank of America and Wells Fargo”).

So, to recap, you get shackled to a house with a recourse loan because you don’t know what the bank and government do.  Meanwhile, your bank gets to forgo a writedown (remember, your loan was for the same amount as before).  And the bank gets a refinance fee which is goosed by government incentives.

Is this predatory lending? Sure sounds like it to me.

Related posts:

• Can I borrow the full amount and an extra 25% too?
• Nationwide brings back 125% LTV mortgages
• The fixed rate mortgage is king again
• Home Equity Lines Pulled
• UK mortgage crunch

Apparently the answer to this question is yes.  CNBC is reporting that home ‘owners’ who refinance their mortgages through loans backed by Fannie and Freddie will be able to borrow up to 125% of their homes’ value (hat tip Marshall Auerback).  That’s not a typo: we’re talking no-money down and 25% cash back.  Sign me up.

Homeowners refinancing their mortgages through loans backed by government agencies will be able to borrow up to 125 percent of their homes’ value under new regulations enacted Wednesday.

The rule changes, part of the government’s attempts to restore housing affordability and stem the foreclosure crisis, apply to loans backed up by Fannie Mae and Freddie Mac.

Previously, homeowners could borrow up to 105 percent of their home’s value. The new loan-to-value ratio is set up at 125 percent in a further effort to address those mortgage holders who owe more than their homes are worth.

"By expanding refinance eligibility, we can bring relief to more struggling homeowners more quickly,” Treasury Secretary Timothy Geithner said in a statement.

Is this sitting well with you?  Doesn’t this seem like the reckless lending which got Fannie and Freddie nationalized? Well, if you were wondering whether Obama, Geithner and Summers were trying to reflate the economy by bringing back the bubble, I don’t imagine you will find better proof.

Apropos borrowing 125%, you will recall that over a year ago I was wondering why U.K. mega-lender HBOS wasn’t writing down more assets because they were a recklessly lending – you guessed it – 125% loan-to-value.

Looking through old e-mails, I read an article from the FT in 2006 that surfaced claiming that HBOS (Halifax Bank of Scotland)were poised and ready to go offer loans for 125% of value. That’s right, HBOS thought it a good idea to cover 95% of the house price and loan another 30% over appraised value unsecured as a personal loan.

Now that the UK has joined the housing bust, one must ask where are the massive writedowns that have to be sitting on HBOS’ books? Why aren’t they looking to do another rights issue like RBS? I fully expect some pretty horrific things coming from HBOS as the housing crisis heats up in Britain.

We know what happened there: HBOS would have gone bust after Lehman had Gordon Brown not foisted it upon Lloyds. And Lloyds was a bank that subsequently was almost fully nationalized despite having a relatively clean balance sheet – all because of its merger with HBOS and HBOS’ reckless lending.

Now that the U.S. government is underwriting similar policies on this side of the pond, shouldn’t we expect things to go seriously pear-shaped here too?

Addendum: just in case it isn’t clear, this measure is intended to keep banks from taking writedowns.  A homeowner now 20% underwater can borrow the full amount of the original loan even though the house is worth 20% less than that amount.  The home ‘owner’ stays in the house.  The bank gets its regular payments (and a nice re-financing fee to goose earnings in Q3).  And no one defaults. It’s all good, right?

Second addendum: Yves Smith, who also got the same e-mail, notes “in most states, a purchase money mortgage is non-recourse, but a refi is. So some borrowers will put themselves in worse shape it they take up this offer.”  Check out her post here.

Related posts:

• HBOS versus Freddie and Fannie
• Treasury Considers Plan to Halt Home Price Slide
• Where’s HBOS?
• Consumer loan delinquencies paint bleak picture
• Is the new affordable FHFA loan program predatory lending?

Bloomberg has the goods on Fannie and they’re not good. Fannie’s regulator wants $19 billion from the U.S. government because the firm has negative capital. Fannie Mae had $23.2 billion in losses last quarter alone. And it says losses in 2009 will be worse than 2008.  Nice.

Here’s the money quote: “Fannie says it does not see itself operating profitably for the foreseeable future.”

Video below.

Related article

Fannie Mae to Tap $19 Billion in Treasury Capital – Bloomberg

Related posts:

• Fannie and Freddie need $75 billion
• CDS Market: Did Fannie and Freddie Default?
• Everyone’s talking about Fannie and Freddie
• Fannie reports $171 billion in non-performing loans
• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds

In case you missed it, Freddie Mac and Fannie Mae have cost taxpayers tens of  billions to date.  The bill is still rising, however, as the two companies are looking for $50 billion more to avoid technical insolvency.

Then there is Citigroup who has had their hands out for $45 billion.  They have also written down over $80 billion in bad assets.  Yet, they are still splurging on corporate jets.

The video below reports on these events, on John Thain’s million-dollar office makeover and more. Needless to say, we have a clear case of banks behaving badly.

Related posts:

• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds
• News round-up: 20 Aug 2008 – financial institutions special edition
• Quote of the day: Gordon Brown, get your bazooka
• Federal takeover of GSEs now in the works
• Fannie and Freddie need $75 billion

Bankruptcy is a necessary part of a free market.  I certainly believe this to be so. Rick Newman, who writes the blog “Flow Chart” over at U.S. News, is putting forward the provocative idea that failure is exactly what we needed more of in 2008 and what we should want in 2009.

The idea is that  propping up bankrupt companies artificially constitutes a dead-weight loss to society and fosters a pernicious sense of invulnerability at many large companies. I tend to agree with these sentiments and this is one reason I do not support the bailouts of the automakers and why I did not support the way other bailouts like Citigroup, Fannie Mae, and Freddie Mac were handled.  However (and this a big however), systemic risk must always be kept in check.  Newman says as much.

OK, so maybe all those bailouts have collectively served the national interest, by preventing a panic and dampening the effects of a nasty recession. But at some point—which we might have passed already—preventing failure does more harm than good. Here’s why we should be more tolerant of failure in 2009:

Bailouts perpetuate the problem instead of solving it. We’re probably about to learn that bailouts are an open-ended—and extremely expensive—proposition. AIG and Citigroup have both asked for one infusion of federal money, then another. Are they done? Or will they come back for even more? The $15 billion in federal loans for General Motors and Chrysler is almost certainly just a down payment on a bailout that could easily total $75 billion or more. And there’s no evidence at all that it will compel more people to buy their cars, which is the real problem. In the end, we might still be stuck with too many automakers building too many uncompetitive products.

So while systemic risk must always be addressed — and that is why I believe the Lehman bankruptcy was a major mistake — failure is part and parcel of the free market.  The government is not there to bail out companies that made poor decisions.  It is there to protect citizens from the ill effects of those poor decisions.

Sources
Needed in 2009: More Failure – Rick Newman, U.S. News
Best Move of 2008: Letting Lehman Fail – Rick Newman, US News

Related posts:

• Bailout Nation
• Sweden: competitive auto bailouts begin with Saab and Volvo
• Citigroup: Panics, Banking Confidence, Bailouts and Fractional Reserves
• AIG: the biggest quarterly loss in corporate history
• GM Board: Bankruptcy is an option we will consider

Marshall here.  Slowly but surely, the Treasury is beginning to move more aggressively on providing help to homeowners, as opposed to bankers.  This makes sense:  A financial meltdown and housing deflation cannot be cured simply by pumping money into the banking system.  You also have to consider a program which provides mortgage relief to homeowners as well.

The Treasury Department is belatedly moving in this direction, by considering a plan to halt the slide in home prices that would lower mortgage rates using Fannie Mae and Freddie Mac. The plan could reduce rates for newly issued loans to as low as 4.5%, according to the Treasury release.  Well, it’s a start.  But looking at this in a bit more detail, I have a problem with it. It is “trickle down” and not direct enough.

The Treasury is looking for the incremental buyer, in this case the U.S. government, to push the rate down by their buying. But this isn’t the same as renegotiating the rates of existing loans, which I believe is what the FDIC wants to do and what I advocated earlier.

And, the Treasury doesn’t know that just because they start buying that the spreads won’t increase or some other factor comes into focus and the rates don’t go down by the desired amount.

If this was the case, well they could buy their own treasurys and force rates to zero (Bernanke threatened to start this yesterday).

While this may be a good first step, it isn’t comprehensive enough and isn’t direct enough.

On another very important note, I made a serious miscalculation in the savings on the at least $2 trillion of variable rate loans that I think (don’t know for sure and it may be much more) are out there. This doesn’t diminish from my proposal but the savings would be “only” say, 3-4% of $2 trillion or $80 billion rather than the hundreds of billions that I had first calculated. Sorry for the bad figures.

But the concept is still the same. And, it is at no out of pocket cost to the government, in fact as I indicated if Fannie and Freddie make the loans they could make 200-300 bp of positive carry which could be a very large number if it continued for more than a few years.

Related posts:

• Treasury to Consider Further Measures to Halt Housing Slide
• Federal takeover of GSEs now in the works
• Fixed rate mortgages at a nine-month high
• Can I borrow the full amount and an extra 25% too?
• A Home Price Firewall

The Treasury Department is considering a plan to halt the slide in home prices that would lower mortgage rates using Fannie Mae and Freddie Mac. The plan could reduce rates for newly issued loans to as low as 4.5%.  Slowly, but surely, the government is moving in the right direction.  It is beginning to dawn on Treasury (albeit, belatedly) that a prerequisite for economic recovery is not just the stabilisation of the banking system, but some sort of program which provides mortgage relief for home owners. This plan is a small start.

I have a problem with this though. It is “trickle down”.

The Treasury is looking for the incremental buyer, in this case the U.S. government, to push the rate down by their buying but this isn’t the same as renegotiating the rates of existing loans.

And, Treasury doesn’t know that just because they start buying that the spreads won’t increase or some other factor comes into focus and the rates don’t go down by the desired amount.

Of course, the Fed could buy longer dated treasurys and force rates lower, as Bernanke proposed the other day in Congressional testimony.

While this proposal may be a good first step, it isn’t comprehensive enough and isn’t direct enough. Why doesn’t government start with jawboning the banks to reduce their outsized margins even at the expense of shareholders? How is it possible that banks are demanding 500 bp margin for variable rate loans? This is the 180 degree polar opposite of the teaser rates back in 2003. It constitutes yet another example of Bush managing things to the benefit of a small group of high end constituents. It doesn’t appear that Congress as a body is smart enough to figure out how to call him on it or doesn’t want to bother during the lame duck period.

On another very important note, I made a serious miscalculation in an earlier posting, regarding the savings on the at least $2 trillion of variable rate loans that I think (don’t know for sure and it may be much more) are out there. This doesn’t diminish from my proposal but the savings would be “only” say, 3-4% of $2 trillion or $80 billion rather than the hundreds of billions that I had first calculated. I apologise for the bad figures. But the concept still stands. Equally significant, there is no out of pocket cost to the government. In fact, as I indicated in my earlier post, if Fannie and Freddie make the loans they could make 200-300 bp of positive carry which could be a very large number if it continued for more than a few years.

Related posts:

• Treasury Considers Plan to Halt Home Price Slide
• Fixed rate mortgages at a nine-month high
• Federal takeover of GSEs now in the works
• Everyone’s talking about Fannie and Freddie
• Dean Baker: I saw this scenario in 2002

Related posts:

• The fixed rate mortgage is king again
• Fixed rate mortgages at a nine-month high
• How refinancing helps the likes of Bank of America and Wells Fargo
• Treasury to Consider Further Measures to Halt Housing Slide
• Treasury Considers Plan to Halt Home Price Slide

When Fannie Mae and Freddie Mac went bust, a number of major players were stung as the value of Fannie and Freddie preferred shares plummeted. Principal amongst these players was Gateway Bank, which had a huge percentage of bank capital tied up in the preferreds.

Now Gateway has arranged a takeover by a rival smaller bank, Hampton Roads Bankshares. Given the options, this is a positive outcome.

Gateway Bank, the coastal lender that took a major hit after the government bailout of Fannie Mae and Freddie Mac, is being swallowed up by a smaller competitor.

The buyer is Hampton Roads Bankshares Inc. (Nasdaq: HMPR), a Norfolk company that’s the parent of the Bank of Hampton Roads and Shore Bank. In the all-stock deal, each share of Gateway (Nasdaq: GBTS) will be traded for 0.67 shares of Hampton Roads.

The companies say they’re valuing the deal at $101 million, based on the 20-day weighted average closing price of Hampton Roads’ stock.

In the transaction, Gateway is being embraced by a significantly smaller company. Gateway’s total assets currently total more than $2 billion, while Hampton Roads Bankshares said it had $845 million in assets as of June 30.

The shotgun wedding was likely prompted by Gateway’s announcement Sept. 11 that it would need to raise capital to stay “well capitalized” under federal rules after writing down a substantial chunk of the value of its $40.4 million in Fannie and Freddie shares. Stock in both Fannie and Freddie sank after the giant mortgage lenders were put under government control earlier this month.

“We believe it is quite remarkable that one of the stronger earning asset growth stories that we cover was relegated to being taken over by a much smaller institution,” Stifel, Nicolaus & Co. analyst P. Carter Bundy wrote in a note Wednesday. “In our view, Gateway’s aggressive investments in Fannie Mae and Freddie Mac placed (the bank) in a rather precarious position.”

Bundy estimates that Gateway shareholders will have about 39 percent of the pro forma company while contributing between 71 percent and 72 percent of loans, deposits and assets.

On Wednesday, Gateway said it still needs to raise some $30 million in capital. If it can do so, and if Gateway and Hampton Roads can get regulatory and stockholder approval, the deal is expected to close in the fourth quarter.

Gateway has five branches in the Triangle: three in Raleigh, one in Chapel Hill and one in Wake Forest. Those branches, as well as the bank’s coastal branches in North Carolina, would continue to operate under the Gateway name if the deal closes.

The combined bank would have about $3 billion in assets.

Related posts
Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds

Source
Reeling from Fannie and Freddie, Gateway to be bought by rival half its size – Triangle Business Journal

Related posts:

• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds
• CDS Market: Did Fannie and Freddie Default?
• Everyone’s talking about Fannie and Freddie
• Freddie and Fannie taken over by US government
• Capital One buys Chevy Chase Bank: Another bailout freebie

In case you missed it, the financial system in the U.S. is near collapse. This weekend was unbelievable. Lehman Brothers filed for bankruptcy. The world’s largest insurer AIG is looking for the Fed to help it avoid collapse and Merrill Lynch was forced to close a deal with Bank of America to save it’s own hide.

Just another day at the office? Hardly. Dow Futures are down 350 points and the FTSE in London is already off nearly 5%. So get ready, this is going to be a very, very difficult day in the markets. Here’s the news of importance:

It all started on Monday last week. In the aftermath of the Fannie and Freddie bailout, market nerves were not calmed. Washington Mutual fired its CEO and announced it had an ominous agreement with the OTS (Office of Thrift Supervision).

Meanwhile Lehman Brothers released an early third quarter earnings report that was widely panned by analysts.

Then, it became obvious that some major losses in the Credit Default Swaps (CDS) market were in the offing due to the takeover of the GSE’s by the government. That was going to hit companies like AIG, which had a huge exposure to the CDS market.

The result was a meltdown in shares of WaMu, Lehman and AIG on Friday.

The Fed called an emergency meeting to deal with Lehman. No agreement was found and Lehman declared bankruptcy early this morning. They have assets of $500 billion

AIG dealt with three buyout shops to shore up its capital base but rejected an offer and went hat in hand to the Fed instead. They have assets of $1 trillion.

WaMu has not seemed to do anything. But rumors are swirling and they will come under great pressure this morning. Oh, and they have assets of $300 billion.

Merrill Lynch was the coup of the day. They struck a deal with Bank of America at a significant premium to both book value and the prevailing market price of their shares. Given what we are likely to see today, Merrill Lynch and its shareholders have to be very very happy. They can say, “thank you very much, John Thain.” Oh, and they have a assets of $1 trillion.

So, we’re talking about combined assets of $2.8 trillion here.

Conclusion
So, the day begins with one company gone (Lehman). Two companies under heavy selling pressure (AIG and WaMu) and one company loving life (Merrill Lynch). Who else should we watch?

All the regional financials, the home builders, and the Commercial Real Estate REITs are all going to be under heavy selling pressure.

Brace yourself!

Related posts:

• Mea Culpa: I was too bullish on the BofA-Merrill deal
• Why Lehman failed
• AIG down; Lehman and WaMu looking to be sold
• SEC charges BofA of lying to investors over Merrill but settles
• Merrill – Bank of America deal

Update 06 Mar 2009: I am re-posting this because I am considering the view that Fannie and Freddie will be used to buy up mortgages, effectively nationalizing the U.S. Mortgage problem (see my last paragraphs). I had seen this as the likely result when the GSE were first put into conservatorship, but the Bush Administration was opposed to such an outcome. This is ever more likely now that Obama is in office.

This is a topic I first broached in May. The United States has a mortgage problem in that house prices have fallen so much and the financial sector is so leveraged that the U.S. faces systemic banking risk from a vicious circle in the mortgage sector. (I normally might have said ‘negative feedback loop,’ but my good reader dearieme pointed out I was misusing the term)

This circle leads from house price declines to foreclosures to bank losses to bank deleveraging and credit tightening leading to more house price declines and on it goes.

Enter Hank Paulson.

By taking over the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac, Paulson can use the two companies, now under government control, to provide fresh liquidity to the mortgage market.

Roots of mortgage nationalization in depression
You see, that is why Fannie Mae, and later Freddie Mac, were created in the first place. On Fannie’s website, it says:

Fannie Mae was created in 1938, under President Franklin D. Roosevelt, at a time when millions of families could not become homeowners, or risked losing their homes, for lack of a consistent supply of mortgage funds across America.

The government established Fannie Mae in order to expand the flow of mortgage funds in all communities, at all times, under all economic conditions, and to help lower the costs to buy a home.
-Fannie Mae

In essence, the Great Depression caused great hardship for Americans because of the destruction of America’s financial system after a wave of bankruptcies in the banking sector. Let’s go back to that painful period of American history.

Bank runs
During the Great Depression, the United States suffered from a similar difficulty of high financial sector debt (see chart below for statistics on debt increase since WWII)coupled with asset losses, eroding banking capital. The result was a loss of confidence in the banking system, causing people to withdraw their deposit money from a number of institutions. These deposit withdrawals created rumor mills that whipped the public into a panic whereby certain banks were deemed so risky that many depositors withdrew funds, so many that the banks were declared insolvent. This is the definition of a bank run, and is exactly what happened to Northern Rock in the UK in 2007.

Funny thing though, insolvent banks don’t lend money because they don’t exist. Therefore, the wave of bank runs and bank insolvencies that resulted from those runs reduced available credit in the system. Hence, irrespective of whatever liquidity the Federal Reserve supplied, the economy — starved of credit – was destined to decline. And decline it did, with output falling 46% in nominal terms and unemployment peaking at 25%.

Mortgage lending
As one could imagine, getting a mortgage in those conditions was pretty difficult. Bank capital was husbanded tightly out of banks’ logical fears of being the subject of the next bank run. Moreover, back then, there were strict interstate banking laws (laws that were only repealed in 1994.) So that meant that a lender was beholden to the local economy — if an area hit the skids, so did its bank, reducing credit availability and further depressing the local economy.

Enter Fannie Mae. Fannie Mae was created as a government agency to eliminate the restriction on mortgage credit availability – exactly the problem we are now experiencing.

Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt’s New Deal to provide liquidity to the mortgage market. For the next 30 years, Fannie Mae held a virtual monopoly on the secondary mortgage market in the United States.

In 1968, to remove the activity of Fannie Mae from the annual balance sheet of the federal budget, it was converted into a private corporation. Fannie Mae ceased to be the guarantor of government-issued mortgages, and that responsibility was transferred to the new Government National Mortgage Association (Ginnie Mae).

-Wikipedia

In 1970, Freddie Mac was created, in order to further expand the government’s role in creating a market for mortgage availability.

The FHLMC was created in 1970 to expand the secondary market for mortgages in the US. Along with other GSEs, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as mortgage-backed securities to investors on the open market. This secondary mortgage market increases the supply of money available for mortgages lending and increases the money available for new home purchases.
-Wikipedia

Conclusion
One might believe for ideological purposes that the government should not be involved in the mortgage market because it distorts investment decisions. I have sympathy for that argument.

However, I also realize that it is times like these that necessitate government’s participation in markets on some level. The U.S. banking system as a whole is clearly undercapitalized and institutions are fearful of becoming the next Bear Stearns or Northern Rock. Therefore, liquidity has evaporated in the money markets and in the mortgage market. As a result, in the mortgage markets, before their conservatorship, Fannie and Freddie were responsible for 3/4 of mortgage lending in the US, up from 50% pre-crisis.

There is little the Federal Reserve could have done to correct this problem. The Fed has already done as much as it can — I would argue more than is prudent — to prevent another Depression-like scenario. It was high time, the U.S. government stepped in to do something. Congress, as useless as ever, did not provide a solution. Therefore, it was up to the executive branch to show some leadership on this issue. And Hank Paulson stepped into the breach.

I do not like many features of his bailout plan because they do not eliminate the moral hazard that was complicit in creating the mess in the first place. His plan is also very political. It protects debt holders like China’s central bank, which holds $400 billion in GSE debt. It protects foreign central banks generally, as they hold $1 1/2 trillion in GSE debt. It protects the likes of Bill Gross, who took a calculated risk in feasting on GSE debt, betting that such a plan was likely to happen. The plan does not wipe out equity capital, nor does it wipe out preferred equity holders entirely. These capital classes should bear all of the initial risk to future capital losses, not U.S. taxpayers.

Moreover, there will be the sticky points of the government running and exiting from Fannie and Freddie. Will politics become an increasing factor in GSE decision-making? How will the GSE’s attract top talent now that the profit motive is gone? How will the government extract itself from the GSEs: will it wind down Fannie and Freddie, hold on to them, or privatize them in part or in full? All of these questions need to be answered.

But Paulson’s plan will be effective on many levels. It will certainly give the mortgage market a boost by lowering mortgage rates and increasing liquidity. This will have the net effect of putting a floor on house price declines in the U.S. and eliminating one of the principal risks to the banking system. And I suspect that the U.S. government will actually increase the GSE’s lending in order to do exactly that. Of course, taxpayers will foot the bill on any lending losses.

So, there you have it. The mortgage problem in America has effectively been nationalized – socialized, if you will. Welcome to the United Socialist States of America. This is certainly not a desirable outcome for the bastion of capitalism that the USA believes itself to be.

But, is there any other solution? Personally, I think not? What do you think?

Sources
Unemployment Rate, U.S. Bureau of Labor Statistics
Federal Reserve Flow of Funds, Federal Reserve

Related posts:

• Pre-payments are reducing value of mortgage-backed securities
• Roubini: Nationalization “fully on the table” in Geithner’s Plan
• Nationalization talk everywhere
• Creeping Nationalization
• Yves Smith: Nationalization is what the FDIC is doing every week

The post-mortems on Fannie and Freddie are flying in. It seems like it is almost non-stop Fannie and Freddie. Let me add to those voices with a bit of a twist: the bailout of Fannie and Freddie was as much a political move as it was a move to save financial markets.

While I see the Fannie-Freddie bailout as flawed, I tend to agree with the likes of Warren Buffett, who said:

It’s the best deal, and the most sensible deal available now. You can argue that there should have been some different rules put in decades ago in terms of what these companies have done, and it wouldn’t have come to this, but those rules weren’t put in by this Administration, or this Congress or this Treasury Secretary, and they face the problem of, in effect, five trillion plus of a combination of portfolio and insurance out there, and, really, chaos in the housing and mortgage markets. So, I would have made exactly, I would have, insisted on something like that, really 80 percent interest at a nominal price to get in there in case the common did have value at some point. And I would have insisted on the priority of common over preferred. I think they made the right deal. It may cost them some money, but it’s going to cost a lot less than anything else they would have done.
-CNBC interview, 8 September 2008

The long and short of the bailout is: you can quibble over details all you want because no bailout is going to satisfy everyone. But, the fact remains that Fannie and Freddie were effectively insolvent and the longer the government waited to act, the worse things were going to get, the more losses we would have had, and the larger the chance of systemic meltdown in the financial sector.

But, more than that, I would argue the bailout is a political construct, first and foremost. On Friday, I enumerated a whole host of reasons that the bailout needed to happen, most of them political. Here are some of the considerations to keep in mind:

• The Chinese, Japanese and other foreign governments are major holders of GSE debt. These governments bought Fannie and Freddie believing them to be equivalent to U.S. government bonds. The Chinese Central Bank is now struggling with capital inadequacy due to the losses they had booked on their GSE investments.

  Now, we can argue that GSE debt holders deserve to take a ‘haircut’ (small loss on their investment) or converted into equity as Bill Ackman advised in order to right the ship equitably.

  But the reality is that the United States, for political reasons, does not under any circumstances want foreign governments to think that the U.S. has defaulted or even partially defaulted on its debt — which is what a haircut or equity conversion is tantamount to. This would be unacceptable and would have severely negative consequences for U.S. markets where foreigners are supplying most of the savings to fund the U.S. current account and government deficit.

• Mutual Funds considered GSE paper to be government bonds too. Go to any mutual fund site, say Vanguard, and you will see that their government bond funds are loaded with debt from Fannie and Freddie (I know because I liquidated all of my government bond fund positions there in February for that reason). Again one could argue that these fund managers should have known better. But, the political reality is they did not and it would be a brave politician who would ‘expropriate’ their investment by converting it into equity or taking a haircut.
• Bill Gross, the manager of America’s largest Bond fund has recently been loading up on GSE paper. He has also been calling agressively for the U.S. Government to do something to stop the asset meltdown in the US, obviously with more than a little self-interest. His voice represents a group of money managers with a lot of political clout. The same political arguments as above hold in not ‘expropriating’ his investment.
• Owning Fannie and Freddie makes controlling the housing market easier. I have had a sneaking suspicion for quite some time that Fannie and Freddie would be nationalized, in part to control the housing market. At present they represent 70% of new issuances in the Mortgage-backed securities market, where their pre-crisis historical share was only 50%. They are effectively the only game in town and without them, mortgage interest rates in the U.S. would be a lot higher.

  With Fannie and Freddie under government control — and with an explicit government guarantee, it will make it a lot easier to keep mortgage rates low and to supply liquidity to the housing market. The U.S. government obviously hopes to prop up housing prices this way. And remember, residential property is Americans’ largest financial asset. With an election in two months, any politician knows that a falling housing market is not good for re-election.

Conclusion?
Before getting into specifics, I want to highlight a quote made by a former Chinese central banker.

“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to questions yesterday. “If it is not the end of the world, it is the end of the current international financial system.”
-Quote of the day: 27 Aug 2008, Credit Writedowns

What one must realize is that the United States is a debtor nation — the largest debtor nation in history. Without the Chinese, the Japanese and the Middle East and their money, things would be much worse in the U.S. The Bush Administration knows this. Hank Paulson knows this. And judging from the previous quote, the Chinese know this too.

A large part of why the United States is not suffering more has to do with foreign governments buying debt issued by Fannie Mae and Freddie Mac under the assumption that it was as good as buying U.S. treasurys — with the upside of an extra 30 or 40 basis points. Therefore, for just that reason, Hank Paulson has protected these debt holders against losses and converted Fannie and Freddie debt into U.S. taxpayer debt.

To do otherwise would be seen by China and other foreign governments as an effective default by the U.S. government. And that just won’t do. Ask Argentina.

Related posts
Quote of the day: 27 Aug 2008 – China
Freddie and Fannie are getting nationalized

Sources
Gross Expects Benefits From Fannie, Freddie Takeover – Bloomberg Video

Warren Buffett Tells CNBC Treasury “Did Exactly the Right Thing” on Fannie/Freddie – CNBC

Related posts:

• Fannie, Freddie to get $15 Billion from U.S. government
• Quote of the day: China hopping mad about GSEs
• Federal takeover of GSEs now in the works
• Everyone’s talking about Fannie and Freddie
• Fannie and Freddie need $75 billion

The finance and investing website Money Morning has a very provocative piece om Jim Rogers today. Rogers, who has been railing against the bailout of Fannie and Freddie for some time, thinks the Treasury and Federal Reserve will fail in their attempts to reflate the U.S. economy. He goes into great detail in his interview with Keith Fitz-Gerald and gives a few tips on sectors to look at for investing.

Enjoy!

Rogers’ candor has made him a popular figure with individual investors, meaning his pronouncements are always closely watched. Here are some of the highlights from the exclusive interview we had with the author and investor, who now makes his home in Singapore:

Keith Fitz-Gerald (Q): Looks like the financial train wreck we talked about earlier this year is happening.

Jim Rogers: There was a train wreck, yes. Two or three – more than one, as you know. [U.S. Federal Reserve Chairman Ben S. Bernanke and his boys both came to the rescue. Which is going to cover things up for a while. And then I don’t know how long the rally will last and then we’ll be off to the races again. Whether the rally lasts six days or six weeks, I don’t know. I wish I did know that sort of thing, but I never do.

(Q):What would Chairman Bernanke have to do to "get it right?"

Rogers: Resign.

(Q): Is there anything else that you think he could do that would be correct other than let these things fail?

Rogers:Well, at this stage, it doesn’t seem like he can do it. He could raise interest rates - which he should do, anyway. Somebody should. The market’s going to do it whether he does it or not, eventually.

The problem is that he’s got all that garbage on his balance sheet now. He has $400 billion of questionable assets owing to the feds on his balance sheet. I mean, he could try to reverse that. He could raise interest rates. Yeah, that’s what he could do. That would help. It would cause a shock to the system, but if we don’t have the shock now, the shock’s going to be much worse later on. Every shock, so far, has been worse than the last shock. Bear-Stearns [now part of JP Morgan Chase & Co. (JPM)] was one thing and then it’s Fannie Mae (FNM), you know, and now Freddie Mac (FRE).

The next shock’s going to be even bigger still. So the shocks keep getting bigger because we kept propping things up and this has been going on at least since Long-Term Capital Management. They’ve been bailing everyone out and [former Fed Chairman Alan] Greenspan took interest rates down and then he took them down again after the “dot-com bubble” shock, so I guess Bernanke could try to start reversing some of this stuff.

But he has to not just reverse it – he’d have to increase interest rates a lot to make up for it and that’s not going to solve the problem either, because the basic problems are that America’s got a horrible tax system, it’s got litigation right, left, and center, it’s got horrible education system, you know, and it’s got many, many, many [other] problems that are going to take a while to resolve. If he did at least turn things around – turn some of these policies around – we would have a sharp drop, but at least it would clean out some of the excesses and the system could turn around and start doing better.

But this is academic – he’s not going to do it. But again the best thing for him would be to abolish the Federal Reserve and resign. That’ll be the best solution. Is he going to do that? No, of course not. He still thinks he knows what he’s doing.

(Q): Earlier this year, when we talked in Singapore, you made the observation that the average American still doesn’t know anything’s wrong – that anything’s happening. Is that still the case?

Rogers:Yes.

(Q): What would you tell the “Average Joe” in no-nonsense terms?

Rogers: I would say that for the last 200 years, America’s elected politicians and scoundrels have built up $5 trillion in debt. In the last few weekends, some un-elected officials added another $5 trillion to America’s national debt.

Suddenly we’re on the hook for another $5 trillion. There have been attempts to explain this to the public, about what’s happening with the debt, and with the fact that America’s situation is deteriorating in the world.

I don’t know why it doesn’t sink in. People have other things on their minds, or don’t want to be bothered. Too complicated, or whatever.

I’m sure when the [British Empire] declined there were many people who rang the bell and said: “Guys, we’re making too many mistakes here in the U.K.” And nobody listened until it was too late.

When Spain was in decline, when Rome was in decline, I’m sure there were people who noticed that things were going wrong.

(Q):Many experts don’t agree with – at the very least don’t understand – the Fed’s current strategies. How can our leaders think they’re making the right choices? What do you think?

Rogers:Bernanke is a very-narrow-gauged guy. He’s spent his whole intellectual career studying the printing of money and we have now given him the keys to the printing presses. All he knows how to do is run them.

Bernanke was [on the record as saying] that there is no problem with housing in America. There’s no problem in housing finance. I mean this was like in 2006 or 2005.
(Q): Right.

Rogers: He is the Federal Reserve and the Federal Reserve more than anybody is supposed to be regulating these [financial institutions], so they should have the inside scoop, if nothing else.

(Q): That’s problematic.

Rogers: It’s mind-boggling. Here’s a man who doesn’t understand the market, who doesn’t understand economics – basic economics. His intellectual career’s been spent on the narrow-gauge study of printing money. That’s all he knows.

Yes, he’s got a PhD, which says economics on it, but economics can be one of 200 different narrow fields. And his is printing money, which he’s good at, we know. We’ve learned that he’s ready, willing and able to step in and bail out everybody.

There’s this worry [whenever you have a major financial institution that looks ready to fail] that, “Oh my God, we’re going to go down, and if we go down, the whole system goes down.”
This is nothing new. Whole systems have been taken down before. We’ve had it happen plenty of times.

SourceJim Rogers: How the Federal Reserve Will Fail and the One Sector Every Investor Should Be In – Money Morning
Rogers Calls Fannie, Freddie Rescue ‘Disaster’ – Bloomberg News

Related posts:

• CDS Market: Did Fannie and Freddie Default?
• Freddie and Fannie taken over by US government
• Freddie and Fannie are getting nationalized
• Fannie and Freddie: The politics of finance
• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds

Today, David Wighton over at the Times Online referenced U.S. Treasury Secretary Hank Paulson’s quip that the U.S. Government had a bazooka ready to us in the case of the Frannie and Freddie Nightmare on Wall Street in saying:

Helping to stabilise the U.S. housing market should bring some benefit to British counterparts. It will also increase pressure on the British to take bolder action. The U.S. will inject up to £110 billion into Fannie and Freddie, arguably the biggest such intervention by any western government since the Second World War. That makes last week’s £1 billion housing package from Gordon Brown look less of a bazooka and more of a peashooter.

The flop is played and the U.S. Treasury has gone all-in. Gordon Brown, over to you.

Source
U.S. bazooka for Fannie Mae and Freddie Mac trumps Brown’s peashooter – Times Online

Related posts:

• FSA: Gordon Brown complicit in credit bust
• Quote of the day: China hopping mad about GSEs
• Fannie, Freddie to get $15 Billion from U.S. government
• Everyone’s talking about Fannie and Freddie
• Federal takeover of GSEs now in the works

Apparently, the answer is yes.

Thirteen “major” dealers of credit-default swaps agreed “unanimously” that the rescue constitutes a credit event triggering payment or delivery of the companies’ bonds, the International Swaps and Derivatives Association said in a memo obtained by Bloomberg News today. Market makers for the privately traded contracts will discuss how to settle them in a conference call at 11 a.m. in New York, the document said. -Bloomberg News (hat tip Market Movers)

This conference call is in one hour’s time. So let’s see what the result is. If this is a credit event, it has the potential to trigger some major, major losses in the CDS market.

“This is a big deal,” said Sarah Percy-Dove, head of credit research at Colonial First State Global Asset Management in Sydney. “The market is not experienced at settling a credit event for a name of this size, so it is a bit of an unknown.”

A settlement likely would be the largest in the market’s decade-long history. Credit-default swaps on Fannie and Freddie have been among the most actively traded the past few months, according to reports from broker GFI Group Inc. Both companies also are among 125 companies in the benchmark Markit CDX North America Investment Grade Index, the most actively traded contract in credit markets, which investors use to speculate on corporate creditworthiness or to hedge against losses.
-Bloomberg News

Also see all my previous posts under the tag GSE, especially the following related posts:

Freddie and Fannie taken over by U.S. government
Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds
Freddie and Fannie are getting nationalized
Quote of the day: 27 Aug 2008 – China
Senator Bunning blasts Bernanke at Senate hearing
Moody’s Cuts GSE Preferred Stock Ratings
Fannie, Freddie to get $15 Billion from U.S. government
Fannie and Freddie: Washington Post articles back to 2005
Question: How is Fannie Mae a AAA company?

Source
Fannie, Freddie Credit-Default Swaps May Be Settled – Bloomberg News

Related posts:

• Fannie and Freddie need $75 billion
• Everyone’s talking about Fannie and Freddie
• HBOS versus Freddie and Fannie
• Fannie and Freddie: The politics of finance
• Freddie and Fannie taken over by US government

If you are looking for the fallout from the Fannie and Freddie Nightmare on Wall Street, look no further than Gateway Financial and Midwest Banc. These two regional banks have nearly one-third of their tangible net worth tied up in GSE preferred stock, which is now worthless.

On August 29th, Business Week reported that these two regional banks had the largest exposure as a percentage of capital to GSE preferred stock. As preferred shares are now nearly worthless as a result of Fannie and Freddie’s conservatorship, these banks may also be effectively bankrupt.

UPDATE: FT Alphaville has a lovely chart of bank exposure to Fannie and Freddie preferreds.

Business Week said the following on August 29th.

Ultimately, the losses to shareholders will be determined by how Treasury decides to treat the companies’ equity if it intervenes to recapitalize the agencies. The market for preferreds is pricing in the risk of some form of government intervention, with some issues trading for as little as 50 cents on the dollar, compared with around 92 cents on the dollar at the end of June, says Sam Caldwell, an analyst who covers regional banks for Keefe, Bruyette & Woods (KBW).

It’s mainly individual investors who have borne the brunt of the losses on the agencies’ common stock, but regional banks, insurance companies, and other financial institutions have taken the hit on the devalued preferreds, and those with a substantial portion of their capital tied up in these securities can ill afford to have all their value wiped out under a government bailout. Fannie and Freddie preferreds account for at least 32% of the tangible capital held by two regional banks—Gateway Financial Holdings and Midwest Banc Holdings—and 5% or more for a slew of others, according to an Aug. 25 report by Caldwell.

While he believes large-cap banks have limited exposure to agency preferreds, Caldwell found 38 banks with aggregate exposure of $1.3 billion, and 81 other banks that said they didn’t hold any preferreds.

A day of reckoning for losses on the agencies’ preferreds could be Sept. 30, when firms will need to mark down the value of the assets on their balance sheets to fair market value. A few regional banks have already taken writedowns for other-than-temporary impairment on the preferreds they hold. Earlier this week, JPMorgan Chase (JPM) said the value of its preferreds has been halved to $600 million this quarter and hinted it will take a charge on those assets when it reports third-quarter earnings.
-Business Week

There are others as well.

Sovereign Bancorp, a regional lender near Philadelphia, holds about $588 million of the securities, about 13 percent of its tangible capital, according to a research report by Keefe, Bruyette & Woods, a securities broker.
-NY Times

There is a lot more exposure here to get a hold of. The Bloomberg article below does a good job of summing up the most vulnerable financial service companies. But, needless to say, Gateway and Midwest Banc are not looking good.

Below is Goldman Sach’s chart of bank exposure via FT Alphaville’s.

Source
Fannie Mae and Freddie Mac: A Damage Report – Business Week
Fannie and Freddie threat to banks – FT
Fannie, Freddie Preferreds Batter Sovereign, Midwest – Bloomberg
Few Stand to Gain on This Bailout, and Many Lose – NY Times
U.S. bank exposure to Fannie and Freddie prefs – FT Alphaville

Related posts:

• Gateway Bank sold, hurt by Frannie preferreds
• CDS Market: Did Fannie and Freddie Default?
• Freddie and Fannie taken over by US government
• Everyone’s talking about Fannie and Freddie
• Fannie, Freddie to get $15 Billion from U.S. government

The U.S. government has finally stepped in to stop the bleeding. Fannie Mae and Freddie Mac, the two giant government sponsored enterprises have been taken into conservatorship and are now government property. As I consider this move a bankruptcy, I will add these two to my list of Global Banking Bankruptcies. These are by far the largest bankruptcies in U.S. history and the move to shore up Fannie and Freddie is unprecedented. The move was widely anticipated and pre-announced by Barney Frank, chairman of the Congressional Financial Services Committee. However, this is still an enormous financial event that will have major consequences on financial markets around the world.

Fannie and Freddie make up half of the U.S. home loan market. If this doesn’t remind one of the Great Depression, then one needs to get in touch with what is really happening to the capitalist system.

Please see sources below for the multiple takes on this news.

The following are the main features of this government bailout. This is a wholesale nationalization of the entire U.S. mortgage problem. Of particular note is the fact that the plan does not say what will happen after conservatorship, i.e. whether Fannie and Freddie will be nationalized permanently, re-privatized or liquidated. Also of note is the extension of a secured line of credit to the Federal Home Loan Banks.

• The Treasury gets $1 billion of senior preferred stock — with warrants — representing 79.9 percent of Fannie and Freddie. The government receives 10% interest on its investment.
• Existing shareholders will still be left with a share of the business but will pick up expected future losses before the taxpayer becomes liable. Obviously, shares in the two organizations are now worthless.
• The U.S. government will now have all voting rights and own 80% of the common stock on a fully diluted basis. Again, the equity of existing shareholders is now worthless.
• Preferred shares have had their ratings slashed to junk, which is not a good sign for them. Bloomberg reports Gimme Credit analyst Kathleen Shanley as saying the takeover is “unambiguously bad” for preferred shareholders who, along with holders of common stock, “will in all likelihood be wiped out.”
• U.S. regulators are very concerned that five or size U.S. regional banks may have outsized exposure to Fannie and Freddie preferreds and will have their capital wiped out. Look for regional banks to be very volatile on Monday morning in U.S. trading. Gateway Financial and Midwest Banc are most exposed.
• Sheila Bair, head of the FDIC said “across the industry, banks do not have significant exposure to GSE equity securities. Any negative impact will be narrowly focused only on a few smaller institutions.” Nonsense. Don’t believe a word of this. You have been warned.
• Fannie and Freddie debt is expected to be backed by the full faith and credit of the U.S. government.
• Any capital shortfalls induced by losses incurred by either organizations will be made up by funds from the U.S. Treasury. The treasury has received a blank check from the U.S. congress and is authorized to make good on any sum to bail out losses at Fannie and Freddie.
• As a result of this unprecedented move, Fannie and Freddie will be forced to reduce their relative size in the U.S. mortgage market. The U.S. Treasury has mandated that the combined Fannie/Freddie portfolio value “shall not exceed $850 billion as of Dec. 31, 2009, and shall decline by 10 percent per year until it reaches $250 billion.” How the government intends to achieve this without the market seizing up due to illiquidity is beyond me. However, Bloomberg says “Fannie’s portfolio was $758 billion at the end of July, and Freddie’s was $798 billion.”
• The executives and Board of Directors of both institutions have been replaced. Herb Allison, a former executive at Merrill Lynch, was picked to head Fannie, and David Moffett, a former vice-chairman of U.S. Bancorp, was selected to head Freddie.
• However, the CEOs of Fannie and Freddie will make out like bandits even though they were effectively fired, the New York Times reports.
  

  Under the terms of his employment contract, Daniel H. Mudd, the departing head of Fannie Mae, stands to collect $9.3 million in severance pay, retirement benefits and deferred compensation, provided his dismissal is deemed to be “without cause,” according to an analysis by the consulting firm James F. Reda & Associates. Mr. Mudd has already taken home $12.4 million in cash compensation and stock option gains since becoming chief executive in 2004, according to an analysis by Equilar, an executive pay research firm. Richard F. Syron, the departing chief executive of Freddie Mac, could receive an exit package of at least $14.1 million, largely because of a clause added to his employment contract in mid-July as his company’s troubles deepened. He has taken home $17.1 million in pay and stock option gains since becoming chief executive in 2003. – NY Times

Related posts
Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds
Freddie and Fannie are getting nationalized
Quote of the day: 27 Aug 2008 – China
Senator Bunning blasts Bernanke at Senate hearing
Moody’s Cuts GSE Preferred Stock Ratings
Fannie, Freddie to get $15 Billion from U.S. government
Fannie and Freddie: Washington Post articles back to 2005
Question: How is Fannie Mae a AAA company?

Also see all previous posts under the label GSE.

Bloomberg Coverage
Paulson Engineers U.S. Takeover of Fannie, Freddie – Bloomberg
Paulson Statement on U.S. Action on Fannie, Freddie: Text – Bloomberg
Statement by Fed Chairman Bernanke on Fannie, Freddie Plans – Bloomberg
Treasury Extends Secured Credit Line to Federal Home Loan Banks – Bloomberg
Regulators to Help Banks With Fannie, Freddie Shares – Bloomberg
Fannie, Freddie Capital Concerns Prompt Paulson Plan – Bloomberg

Important Sidenotes
Few Stand to Gain on This Bailout, and Many Lose – NY Times
Fitch Affirms Fannie Mae & Freddie Mac’s ‘AAA’ IDR; Lowers Pfd Stock; Sub Debt on Watch Evolving – Market Watch
Pimco’s Bill Gross on the Fan/Fred rescue: “We like it” – LA Times
Futures soar after U.S. takes over GSEs – Reuters
S&P, Fitch slash Fannie, Freddie preferreds to junk – Reuters
Fannie Mae and Freddie Mac: A Damage Report – Business Week

Other Sources
U.S. government seizes control of Fannie Mae and Freddie Mac – Times Online
U.S. steps in to rescue failing home loan giants – Guardian
Banks surge after Freddie, Fannie bailout – Sydney Morning Herald
Wall St set for frantic day after Fannie Mae and Freddie Mac bail-out – Telegraph
US-Regierung fängt Fannie und Freddie auf – Financial Times Deutschland

Related posts:

• CDS Market: Did Fannie and Freddie Default?
• Everyone’s talking about Fannie and Freddie
• Fannie, Freddie to get $15 Billion from U.S. government
• US government discusses Fannie and Freddie bankruptcy
• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds

A prediction I first broached here in May in my post Question: How is Fannie Mae a AAA company? is finally coming to pass: Freddie Mac and Fannie Mae are getting nationalized.

UPDATE: The U.S. Government takeover is now a done deal. See my post on the details of the merger with a plethora of links to other news sources.

NOTE: The deal will have bad implications for shareholders and preferreds. See My post on the implications on the preferreds.

Oh, aren’t you happy Bill Gross?

Back in May, I said

The only answer is the implicit government guarantee. Fannie Mae and Freddie Mac are too important and too big to fail. In fact, the U.S. government may need to ‘re-nationalize’ these organizations to conduct a clean up of the mortgage mess.

With many subsequent events having passed since then making Fannie and Freddie yet more fragile, the time has come and Hank Paulson has taken the step.

Bloomberg said today:

Treasury Secretary Henry Paulson met with regulators and executives of Fannie Mae and Freddie Mac today as the Bush administration prepared to announce a plan to prop up the firms hit by $14.9 billion in losses the past year.

It’s about time.

The list of reasons why the Fed and the Treasury needed to intervene are increasing by the day, with each new revelation more srious than the last:

• Freddie and Fannie are essentially bankrupt institutions. Stock market investors triggered a massive selling wave that engulfed the entire financial sector when shareholders began to believe a bankruptcy was imminent and that shares would go to zero. Even investing sage Warren Buffet is on record as saying a bailout is going to happen. On a CNBC interview on August 22nd, he said “you will see some action fairly soon”and “the game is over.” I don’t think there is any doubt what he thinks.
• The bond market thinks the same thing as credit spreads widened on Fannie and Freddie paper even after an explicit unlimited backstop from the Treasury was made. Fannie and Freddie preferreds have been downgraded by Moody’s to reflect this risk as well. Preferreds and shareholders will likely be wiped out in bankruptcy.
• Bond King Bill Gross seems to be getting more agitated by the day by the credit situation, just recently opining that he might go on strike and refuse to buy any more paper. PIMCO is stuffed to the gills with GSE securities. Gross wants to ee a payoff
• The Chinese Central Bank has been hemorrhaging losses due to the loss of value in their GSE assets. The bank has only $3 billion in equity capital left despite its trillions in assets. The losses on their portfolio have made them need to go hat in hand to the Chinese Treasury for a bailout. They are very angry about this situation.

It doesn’t get more serious than all of this. Now the Feds are going to put an end to our misery.

The plan is likely to involve putting at least one of the companies under government control in a conservatorship, according to a person briefed on the discussions. The move may also result in changes in the leadership of Fannie and Freddie, said the person who spoke on condition of anonymity.

Pacific Investment Management Co., manager of the world’s biggest bond fund, and other large investors may put in their own money once the Treasury decides to inject government funds, said Newport Beach, California-based Pimco fund manager Bill Gross, in a Bloomberg Television interview.

The meetings come a month after Paulson hired Morgan Stanley to advise on any use of taxpayer funds to recapitalize Fannie and Freddie, which account for almost half of the $12 trillion U.S. mortgage market. A government takeover would be the latest attempt to blunt the impact of the yearlong credit crisis, after the Federal Reserve provided financing for Bear Stearns Cos.’s takeover by JPMorgan Chase & Co.

Paulson gathered with Federal Reserve Chairman Ben S. Bernanke, Fannie Mae Chief Executive Officer Daniel Mudd, Freddie Mac CEO Richard Syron and Federal Housing Finance Agency director James Lockhart in Washington. The Treasury plans to brief Democratic presidential candidate Barack Obama’s campaign team tomorrow and has contacted Republican contender John McCain’s staff about its intentions.

`Open Their Wallet’

“They have to open their wallet,” Gross said, adding that the Treasury will want to act before the FHFA releases an assessment of Fannie Mae’s and Freddie Mac’s capital later this month.

The Washington Post reported that government officials told Fannie and Freddie they plan to put them into a conservatorship, where common stock would be diluted while not wiped out, citing sources it didn’t name. Debt and preferred shares would be protected, and the government would make quarterly injections of funds as the companies’ losses warranted, the Post said.

Washington-based Fannie and Freddie dropped in after-hours trading. Fannie dropped $2.25, or 32 percent, to $4.79 at 5:50 p.m. in New York Stock Exchange trading and Freddie slumped $1.40, or 27 percent, to $3.70.

Paulson has made no public comment on the backstop for Fannie and Freddie since Aug. 10, when he reiterated he had “no plans” to use his authority. Shares in Freddie and Fannie have dropped 9 percent and 16 percent, respectively, since then as investors and analysts called for Paulson to clarify his intent.

`Making Progress’

“We are making progress on our work with Morgan Stanley, FHFA and the Fed,” Treasury spokeswoman Brookly Mclaughlin said today in Washington.

Should any public money be injected into Fannie and Freddie, “the management and board should immediately be replaced, multimillion-dollar salaries should be cut, and bonuses and other compensation should be eliminated,” McCain wrote in a July.

Obama last month echoed that position, saying he had “no sympathy” for Fannie and Freddie’s CEOs. The government has to decide whether the companies should be made private or taken “out of the profit-making business,” he said.

Mudd and his aides have also been meeting at the FHFA, which oversees the two firms, with catered food scheduled for delivery at the agency through the weekend.

Fed Role

Bernanke participated in today’s meetings because the central bank was given a consultative role in overseeing Fannie’s and Freddie’s capital under the July legislation.

Mudd and Syron must approve of any government intervention under the law, unless the FHFA declares that either firm has insufficient capital. The legislation gave the Treasury the power through the end of next year to extend unlimited credit to or make equity purchases in the firms.

The FHFA was scheduled to release its own assessment of the companies’ capital levels as early as this week as part of a quarterly appraisal of their finances.

Analysts have speculated that the Treasury would wipe out common shareholders, while seeking to shield preferred stockowners from total loss. Fannie and Freddie preferred shares are typically owned by banks and insurance companies. Their $5.2 trillion of debt outstanding is held by investors including Asian central banks, and would probably be guaranteed, analysts said.

Raising Capital

A specific fallback plan should Fannie and Freddie fail may enhance their ability to raise new private capital, said Alex Pollock, fellow at the American Enterprise Institute in Washington and former president of the Chicago Federal Home Loan Bank.

“Treasury’s main concern is the debt markets, and if it was to say that it will do whatever is necessary to keep Fannie and Freddie running, the better it is for their funding,” Pollock said. “If Treasury makes it clear they have a plan ready to go, that would certainly help.”

Mclean, Virginia-based Freddie Mac’s board this week relaxed its ownership rules to make it easier for investors to take a large stake in the company. It rolled back a rule in its bylaws that precluded owners with a 20 percent or more controlling interest from voting without the approval of all other shareholders.

The two companies need to sell billions of dollars of bonds each month to pay off maturing debt, and have continued to issue securities this week.

Mudd at FHFA

Mudd was accompanied by Fannie General Counsel Beth Wilkinson and Chairman Stephen Ashley in his visit to FHFA this afternoon.

FHFA spokeswoman Stefanie Mullin declined to comment, as did Mark Lake at Morgan Stanley.

The Wall Street Journal reported earlier that Paulson is close to completing a plan that includes changes of senior management, according to an unidentified person familiar with the matter. The Journal also said the plan involved what it called a creative use of the Treasury’s powers, without citing anyone.

-Bloomberg News

This is a huge story that must be resolved as soon as possible in order not to cause a market panic. Let’s hope the Treasury and Federal Reserve can pull this off smoothly.

Expect to hear much more as time goes along.

Related posts
Quote of the day: 27 Aug 2008 – China
Senator Bunning blasts Bernanke at Senate hearing
Moody’s Cuts GSE Preferred Stock Ratings
Fannie, Freddie to get $15 Billion from U.S. government
Fannie and Freddie: Washington Post articles back to 2005
Question: How is Fannie Mae a AAA company?

For other posts on Fannie and Freddie see ‘GSE ‘ tag.

Sources
Paulson Meets With Bernanke, Fannie, Freddie Chiefs – Bloomberg
Buffett predicts game over for Fannie and Freddie – Times Online

Related posts:

• Fannie, Freddie to get $15 Billion from U.S. government
• Freddie and Fannie taken over by US government
• Paulson Sunday Statement on Fannie and Freddie
• CDS Market: Did Fannie and Freddie Default?
• Everyone’s talking about Fannie and Freddie

At the end of last week, the warning came. The Chinese officially warned Hank Paulson et al. that they better get their act together on Fannie and Freddie. The Chinese own a ton of GSE paper and they would be hopping mad to see their investments lose value.

The implicit threat is that the Chinese will cut the dollar loose if Fannie and Freddie fail. If the dollar falls precipitously against China’s currency, then all bets are off regarding the future course of the U.S. economy and inflation. That said, it remains to be seen whether the Chinese would make good on their threat as it would cause problems for the China and its export market as well.

In the end, the comments highlight how excessive pending by the U.S. has led to the relative weakness in geopolitics. But, so it is when one depends on the kindness of foreign governments.

“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to questions yesterday. “If it is not the end of the world, it is the end of the current international financial system.”
-Yu Yongding, former adviser to China’s Central Bank

Related posts:

• Conservatorship of GSEs is bad for the dollar and inflation
• Federal takeover of GSEs now in the works
• Fannie and Freddie: The politics of finance
• Quote of the day: Gordon Brown, get your bazooka
• Dollar strength is an illusion

Caroline Baum is one of the more insightful financial market pundits around. In her column she takes aim at Fannie and their private reward, public risk corporate setup. Basically, the Fannie-Freddie bailout is a simple case of “heads and management wins, tails and taxpayers lose.”

Two weeks ago, with their stock prices plummeting and accusations of insolvency swirling through the marketplace, Fannie Mae and Freddie Mac, the two giant mortgage-finance companies, stared into the abyss.

What looked like a black hole turned out to be a blank check from the U.S. Treasury: an unspecified and unlimited credit line, borrowing privileges at the Federal Reserve’s discount window, and a pledge of a capital injection from the government if needed.

The Securities and Exchange Commission coughed up additional protection, tightening the rules for short-selling of Fannie and Freddie, along with 17 other financial stocks.

Mission accomplished? With the government making explicit the implicit guarantee of the two government-sponsored enterprises, which together own or guarantee $5.2 trillion of the nation’s $12 trillion of mortgage debt, the hope is that Fannie and Freddie won’t have to tap the emergency backstops.

The fear is that the needed makeover will stop there.

If these public-private hybrid companies are too big to fail — and everyone from the Bush administration to Congress to businesses and homeowners agrees that they are — then by definition they are too big to survive in their current state, a paradox voiced by William Poole, former president of the Federal Reserve Bank of St. Louis, in a July 27 New York Times op-ed.

As a result, Baum says the Bush administration should stop dithering on making the Fed a super regulator and address the Fannie and Freddie problem head on.

A “world class” regulator isn’t the solution. Eliminating the asymmetric risk/reward from Fannie and Freddie is.

If the taxpayer is going to shoulder the burden for bailing out Fannie and Freddie, the taxpayer should stand to benefit. It makes no sense to guarantee the debt of a private company, the benefit of which accrues to the shareholders, and not own the equity.

The Bush Administration and Congress cannot leave the GSEs as they are. They have two options:

• Break them up and fully privatize the two organizations, diminishing their market role and leverage and taking away the government backstop. Private companies do not have implicit or explicit government backing
• Nationalize them in full

The present state of affairs is a sham.

Source
Fannie Mae, Freddie Mac Live to Die Another Day: Caroline Baum, Bloomberg News, 30 Jul 2008

Related posts:

• Federal takeover of GSEs now in the works
• Everyone’s talking about Fannie and Freddie
• HBOS versus Freddie and Fannie
• Fannie, Freddie to get $15 Billion from U.S. government
• US government discusses Fannie and Freddie bankruptcy

The day is almost over for the market (thank goodness) and it seems that financal service investors are in panic mode again. The market is down over 250 points and some shares in financial services are down over 15%. What gives?

As we may soon find out, non-market based economic solutions, like the infamous SEC list of 19, always have unintended consequences. After a great rally in financial shares of more than 50% to the upside, we are having another bruising day — and for no apparent reason. It seems likely we have just seen the end of a terrific short-covering rally.

Since the SEC has scared the shorts out of financials in order to prop the sector up, fewer investors are willing to buy bank shares when they fall. This means we could see some gapping down in financials on minimal signs of stress in the sector. That leaves the weaker financials exposed to bankruptcy.

Certainly, the awful home sales data has a lot to do with the selling as homebuilders like Lennar are off over 20% on the day. But, one month’s housing data does not a trend make. Another possible reason for today’s market selloff in financials in particular is rumors about Washington Mutual’s solvency.

Washington Mutual Inc. tumbled more than 20 percent for a second day as Gimme Credit LLC said unsecured creditors were “pulling funds” from the biggest U.S. savings and loan.

Gimme Credit analyst Kathleen Shanley cited the decline in federal funds purchased and commercial paper to $75 million from $2 billion at year-end, which Washington Mutual reported this week in its second-quarter results. Securities sold under agreements to repurchase dropped to $214 million from $4.1 billion at the end of 2007, she wrote.

Washington Mutual, known as WaMu, reported a $3.3 billion second-quarter loss on July 23. Rising delinquencies forced the Seattle-based company to boost provisions for bad loans. While WaMu said it has enough capital after raising more than $7 billion earlier this year, Shanley said liquidity remains a concern.

“We won’t use the phrase `run on the bank,’ but we would be remiss if we did not observe that many creditors have quietly been pulling funds,” wrote Shanley, based in Chicago. Their actions are “presenting an increasing funding challenge,” she wrote. Gimme Credit is an independent research firm serving corporate bond investors.

-Bloomberg, 24 Jul 2008

Rumors don’t cause banks to implode. Inherent distrust and financial institution weakness do. Is anyone spreading rumor about Goldman or Credit Suisse? The ironic thing about this particularly ugly day is that Fannie and Freddie are both down over 15% when the government’s actions were suposed to stop selling pressure.

When selling pressure begins again in earnest, the weakest financial institutions will be exposed to downside pressure like never before — with no shorts to buy when their shares fall. A major financial sector bankruptcy will then be in the offing. And some home builders are sure to go down as well. These are some unintended consequences that are sure to anger taxpayers when the GSE and FDIC bills comes due.

Related posts:

• Market turmoil confirms FDIC’s tough position
• Brace yourself!
• Massive short covering at VW and massive losses for hedgies
• Financials: catching a falling knife
• Quality financials are out there

The U.S. House of Representatives has passed the housing bailout bill helping troubled mortgage borrowers, but also giving the U.S. Treasury Department a blank check to support Fannie Mae and Freddie Mac. The New York Times describes it this way:

Representative Barney Frank, Democrat of Massachusetts and a primary author of the legislation, said troubled homeowners might get relief within days of Mr. Bush signing the bill, because lenders have long known details of the legislation and could move quickly to help borrowers refinance. “Many of these institutions know this is coming,” he said. “I hope they will be able to take advantage of it right away.”

But the legislation, much of which has been debated and fretted over on Capitol Hill for months, also leaves numerous questions unanswered. The biggest unknown is whether the measure will be adequate to slow the downward spiral of home prices and help the economy recover from what many analysts now expect to be a prolonged slowdown.

Perhaps most significantly, the legislation hardens the government’s long-implicit assurance that it would step in to rescue the two mortgage giants who together own or guarantee about $5.2 trillion of the nation’s $12 trillion in mortgages. Currently, Fannie Mae and Freddie Mac guarantee financing for about 80 percent of new mortgages.

To accommodate a potential rescue for Fannie Mae and Freddie Mac, the bill raises the national debt limit to $10.6 trillion, an increase of $800 billion.

The Treasury Department has said it hopes never to use the authority to spend unlimited taxpayer funds — perhaps hundreds of billions of dollars — to maintain the solvency of the mortgage giants because they are in sound financial condition. Still, shares in the two companies rose sharply on Wednesday in a sign of the market’s positive view of having a federal rescue plan in place.

-NY Times, 24 Jul 2008

What I find most galling about this bailout is the taxpayer support for Fannie and Freddie. Think back to earlier in the week when a large global bank ran into problems with serious writedowns and was forced to raise capital. I’m not talking about Fannie or Freddie. I am talking about HBOS:

HBOS today revealed that take-up of the £4bn fundraising, which was unveiled on April 29, was just 8.29pc .

“The message is loud and clear: people still don’t really want to buy banking stocks,” Julian Chillingworth of Rathbone Brothers told Bloomberg.

“From an HBOS point of view, they have shored up their balance sheet and improved overall capital ratios. They have achieved what they set out to do.”

The volatile markets are likely to have played a major role in the decision to shun the rights as shares in HBOS fell to as low as 225p on Wednesday before closing at 254p as concerns about U.S. mortgage lenders Fannie Mae and Freddie Mac weighed on sentiment.

-Telegraph, 21 Jul 2008

Here are Fannie and Freddie’s weakness causing market panic that pulled down the entire global banking sector, helping HBOS to the record for the largest rump of shares EVER left in UK history after a rights issue. And, what happens later that week to these two publicly traded companies? They get a massive bailout from the U.S. government.

HBOS can’t place its shares because no one wants them — in part because of the GSE’s; they must actually fear for their very existence in the event of needing more capital. Meanwhile Fannie and Freddie get a gurantee from the government that the government will supply them with unlimited capital if they can’t place their shares. Does that seem fair to you? Does that represent free market economics? I think not.

What the U.S. government must do is end the charade that these are private sector companies, beholden to the same risk of failure of other companies. They are not. Freddie and Fannie have effectively been nationalized.

Related posts:

• Everyone’s talking about Fannie and Freddie
• Federal takeover of GSEs now in the works
• US government discusses Fannie and Freddie bankruptcy
• Fannie, Freddie to get $15 Billion from U.S. government
• Fannie and Freddie need $75 billion

Senator Jim Bunning (R-KY) blasted Fed Chairman Ben Bernanke, who was giving the semiannual monetary policy report before the Senate Banking, Housing and Urban Affairs Committee today. His comments were the sharpest I heard throughout the hearing. The hearing is expected to be brief in order to make time for a later joint hearing with Bernanke, U.S. Treasury Secretary Paulson, and SEC Chairman Cox before the same committee. Chris Dodd (D-CT) is the chair.

He read a prepared statement that is on his website:

As Prepared For Delivery:

Thank you, Mr. Chairman. I know we have a lot of ground to cover today, but I want to say a few things on the topic of this hearing and of the next.

First, on monetary policy, I am deeply concerned about what the Fed has done in the last year and in the last decade. Chairman Greenspan’s easy money the late nineties and then following the tech bust inflated the housing bubble and created the mess we are in today. Chairman Bernanke’s easy money in the last year has undermined the dollar and sent oil to new record highs every few days, and almost doubling since the rate cuts started. Inflation is here and it is hurting average Americans.

Second, the Fed is asking for more power. But the Fed has proven they can not be trusted with the power they have. They get it wrong, do not use it, or stretch it further than it was ever supposed to go. As I said a moment ago, their monetary policy is a leading cause of the mess we are in. As regulators, it took them until yesterday to use power we gave them in 1994 to regulate all mortgage lenders. And they stretched their authority to buy 29 billion dollars of Bear Stearns assets so J.P. Morgan could buy Bear at a steep discount.

Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed. Instead, we should give them less to do so they can do it right, either by taking away their monetary policy responsibility or by requiring them to focus only on inflation.

Third and finally, since I expect we will try to get right to questions in the next hearing, let me say a few words about the G.S.E. bailout plan. When I picked up my newspaper yesterday, I thought I woke up in France. But no, it turns out socialism is alive and well in America. The Treasury Secretary is asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed’s purchase of Bear Stearns’ assets was amateur socialism compared to this.

And for this unprecedented intervention in the markets what assurances do we get that it will not happen again? None. We are in the process of passing a stronger regulator for the G.S.E.s, and that is important, but it allows them to continue in the current form. If they really do fail, should we let them go back to what they were doing before?

I will close with this question Mr. Chairman. Given what the Fed and Treasury did with Bear Stearns, and given what we are talking about here today, I have to wonder what the next government intervention in private enterprise will be. More importantly, where does it stop?

-Bunning Senate Website

Very strong words and right on target. Other Senators should take notes.

Related posts:

• Bloomberg’s Caroline Baum picks up on Bunning
• Obama to re-appoint Bernanke
• Caroline Baum: Dollar Policy for Dummies
• Bernanke expects recovery later this year
• Bernanke is responsible for the market meltdown