Michael Gracie

According to a New York Times report from early this morning, the Bush Administration is considering taking temporary control of Fannie Mae and Freddie Mac. That was quick.

First and foremost, this doesn’t mean bankruptcy, but it does mean the equity holders would get wiped out. It sounds like “receivership” too, but it’s not that - a receiver is generally engaged with an enterprise to extract what’s owed to creditors, particularly where those creditors have liens on the entity’s assets. No, we’re talking something more akin to a judge designating a guardian for a mentally incapacitated adult. A conservator monitors, and steps in with power of attorney to make decisions as need be. In this case, it’s going to be a lot like having a new board of directors, potentially new management, and likely a guarantee of bond payments. Or at least let’s hope.

SIDE NOTE: What this may also mean is that liquidity for home mortgages, including the wild bailout notions that the government conjured, is going to dry up. While the government guarantee might stir reason for Fannie and Freddie’s borrowing costs to go down (i.e. the spread between their paper and that of the US Treasury should shrink to nothing) and hence mortgage rates to follow, I contend the markets have a way of surprising people. The prime lending rate actually remained fairly stable during a big portion of the housing run up (some analysis will follow in a later post). What really set things afire was the liquidity that securitization provided - Fannie and Freddie were a big cog in that liquidity engine, while the banks and brokers reaped the benefits. The GSEs and their partners are now hamstrung, meaning the previous buyers of that paper (the investors that never seemed to be at the negotiating table during the bailout talks) will be hard pressed to continue the buying spree.

UPDATE: Still tumbling:

Investors appeared unimpressed by a statement from Treasury Secretary Henry Paulson, who said the government’s focus is ensuring that Fannie Mae and Freddie Mac remain as presently constituted to carry out their mission. Some investors had been hoping that the government would announce plans to take over one or both of the companies.

I think Hank Paulson is too intelligent to believe the concept that Fannie Mae and Freddie Mac will remain in business-as-usual mode and/or be capable of assisting struggling homeowners. Even if the GSEs are able to raise more capital on the back of a government guarantee, the credit markets suggest that the yields will have to be higher. This means either F & F will have to pass on that cost to homeowners or suffer continuing losses.

In other words, without buyers for those bonds there is no housing bailout.

UPDATE 2: Of course, Congress critters and their lobbyist pals are still enthusiastic. This may mean the GSEs now go straight to liquidation.

Following up on the “insolvency” bit…

• Hank Paulson sidesteps questions on the issue. Let’s also note that “government-sponsored” does not mean government guaranteed, and obviously Mr. Paulson knows this.
• The doomsday scenario, noting the government is counting on the siblings to fix the housing problem. Raising those caps isn’t looking like such a bright idea, just months later.
• The Legg Mason Value Trust and its manager Bill Miller are feeling the pain. I feel a bit sorry for the fund owners - buying into drops is rarely a good idea.  What goes down can hit the ground - gravity rules us all.
• But everyone breath easy - as has been said time and time again, they’re “adequately capitalized“…

Via Bloomberg:

Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae’s assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.

Raising additional capital here is a tricky issue. Existing equity holders have been decimated, and infusions are going to cut them off at the knees. They’d like their knees. But new money is a foregone conclusion if bondholders are to continue getting paid. Plus, the equity holders would have to walk in a restructuring situation, but at the same time the right side of the balance sheet is byzantine - there would be more classes of creditors than you could waggle a telephone pole at.

These are GSEs - sovereign wealth funds will not be stepping up to the plate; the Fed, maybe with the cooperation of money center banks, will most certainly be taking some action, and soon.

UPDATE: You have to step back a few years to find Fortunes’ blow by blow on the GSEs (around accounting scandal time). Good stuff, and well worth the read. I’m guessing nobody read it back then.

Accrued Interest has the straight-talk on the balance sheet of Fannie Mae’s brother Freddie. The highlight of the Q & A is this loaded question…

Q: Freddie Mac’s senior debt rating is still AAA, which is about as much bullshit as Ambac. How can these guys keep losing money quarter after quarter and retain that rating?

So spot on I didn’t even bother reading the answer - I was overcome with the amusement of “truthiness.”

(h/t to Calculated Risk)

UPDATE: Jonathan Weil has a diagnosis for Freddie Mac…temporary insanity.

UPDATE 2: More on ratings here.

You’re on the board of a couple of big companies. Their business is investing in home mortgages, and you force them to be moderately picky about what they buy. It can’t be too big, and must garner a sufficient rate of interest over a sufficient length of time. You also subsidize these companies through loan guarantees - it’s the only way anyone will buy their debt. Meanwhile, the companies’ management really has your ear because they take you out on the town a lot, and their private-sector brethren foot the bill.

By the way…how are those companies of yours performing? Well, they’re losing tens of billions of dollars each quarter, with little end in sight.

What do you do?

A) Nothing, and let the markets weed out all the garbage over the next two years or so
B) Recommend getting rid of all their analysts, and go party with the CEO
C) Vote for a top management shake-up, and go party with the private-sector folks
D) Relax their investment restrictions, giving them yet more avenues to lose their investors’ money

It’s a tough call. But if you picked “D” you’ve won!

You can’t make this stuff up.

Via Reuters:

Countrywide Financial Corp Chief Executive Angelo Mozilo sold some of his shares in the No. 1 U.S. mortgage lender to handle matters relating to his estate and retirement, former Countrywide board member Henry Cisneros said on Fox Business Network on Wednesday…

Mozilo has realized more than $100 million of gains in the last year since he began selling shares on a regular basis last October, just as the U.S. housing market was cresting. He later accelerated the pace of those sales twice.

Meanwhile…

Countrywide Financial Corp’s chief executive called on the U.S. Congress to temporarily raise the maximum size of mortgages that Fannie Mae, Freddie Mac and the Federal Housing Administration may buy or insure by 50 percent to $625,000…

Any increase in the cap should benefit Countrywide, which now primarily makes home loans that Fannie Mae and Freddie Mac can buy.

Admittedly, the stock needs help.

UPDATE: Adding insult to injury, the company is still promoting low-money-down loans. What the heck - someone else takes the heat anyway.

UPDATE 2: More suffering, and more predicted, from the very ones now being hornswoggled into picking up the “slack.”