Mortgage giants may enter conservatorship

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.

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