Nationalizing Fannie and Freddie: Latest Move in the Housing Crisis

by: Brad DeLong September 07, 2008 | about stocks: FNM / FRE    

Brad DeLong

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

Henry Paulson did it: He nationalized the GSEs Fannie Mae and Freddie Mac.

OK. Here is what is going on:

* Fannie Mae and Freddie Mac give the Treasury each 80% of their (common) stock and $1B (each).

* The Treasury promises to keep Fannie and Freddie solvent according to GAAP by lending it money at 10% per year.

* The Treasury promises to keep Fannie and Freddie liquid by buying its MBSs, financing the purchase by selling more Treasury bonds, and then holding the GSE MBSs to maturity.

* The Treasury, the Fed, and the FHFA will agree on an additional amount -- a "commitment fee" -- that Fannie Mae and Freddie Mac must pay to the Treasury starting in March of 2010.

This deal seems to me to be motivated by five things:

* Paulson's desire to make sure that there is no way in hell that either Fannie or Freddie can ever be adjudged insolvent according to GAAP -- which would trigger all kinds of bond-market unpleasantness.

* Paulson's desire to make sure that there is no way in hell that either Fannie or Freddie will wind up illiquid--out of cash.

* Paulson's desire to make sure that there is no way in hell that Fannie Mae's and Freddie Mac's stockholders profit substantially out of this.

* Paulson's desire to make sure that there is no way in hell that the CBO can calculate that this deal is likely to cost the government money -- if CBO threatens to so conclude, he can always up the commitment fee.

* Paulson's desire to keep the options open for his successor to shape the long-term debate about how to restructure these GSEs.

Terms of the Agreements:

* The agreements are contracts between the Department of the Treasury and each GSE. They are indefinite in duration and have a capacity of $100 billion each...

* If the Federal Housing Finance Agency determines that a GSE’s liabilities have exceeded its assets under generally accepted accounting principles, Treasury will contribute cash capital to the GSE in an amount equal to the difference between liabilities and assets. An amount equal to each such contribution will be added to the senior preferred stock held by Treasury ... senior to all other preferred stock, common stock or other capital stock to be issued by the GSE...

* In exchange for entering into these agreements with the GSEs, Treasury will immediately receive

  • $1 billion of senior preferred stock in each GSE
  • Warrants for the purchase of common stock of each GSE representing 79.9% of the common stock of each GSE on a fully-diluted basis at a nominal price

* The senior preferred stock shall accrue dividends at 10% per year. The rate shall increase to 12% if, in any quarter, the dividends are not paid in cash, until all accrued dividends have been paid in cash....

* Beginning March 31, 2010, the GSEs shall pay the Treasury on a quarterly basis a periodic commitment fee that will compensate the Treasury for the explicit support provided by the agreement. The Secretary of the Treasury and the Conservator shall determine the periodic commitment fee in consultation with the Chairman of the Federal Reserve. This fee may be paid in cash or may be added to the senior preferred stock...

Related Articles

This article has 11 comments:

  •  
    Sep 07 05:20 PM
    So, the "free market" is only free until it isn't.
    Nationalization of the Freddies: another one of the accomplishments of 8 years of Republican rule.
    4 more years!!!!
    Reply | Link to Comment
  •  
    Sep 07 06:09 PM
    Since FNM and FRE are purportedly privately held companies, wouldn't there need to be a shareholder approval for this deal?

    Or do the Corporate bylaws for each include wording to the effect that the company can do whatever they want without shareholder approval?

    Seems like diluting common share value to ZERO would be something most shareholders might take an interest in and, just maybe, they'd want a chance to vote on the matter like any REAL corporate shareholder would.

    Oh, I forgot, it's all for the benefit of the politically connected so the shareholders should be happy they got robbed.

    Never mind.

    Question 2: If nobody else in the private sector will make mortgage loans (risking their own money), how can the Treasury expect to continue on as before without losing billions more in the future?

    What will the gub'ment do with all the houses they "buy" through foreclosure at bubble prices that nobody will pay 50 cents on the dollar for in the open market?

    Again, billions more in losses on the way. But hey, at least the banks are off the hook right?

    Expect your tax burden to grow accordingly.
    Reply | Link to Comment
  •  
    Sep 07 06:15 PM
    What this means is that the U.S. Government has collapsed. Now all stock markets will collapse.
    Reply | Link to Comment
  •  
    Sep 07 06:47 PM
    As a holder of $25k of Fannie Mae preferred I just got screwed. It was brought about by the local realtors, banks, mortgage brokers and the Wall Street 'financial engineers' who created the investment vehicles. Mortgages were given blindly without credit approvals, and standards. As a former credit mgr. for a Fortune 100 company I can assure I would have been fired for approving any such poor risk.

    You can bet the amongst listed participants will never have to give their commisions and bonuses back for what they created. I can also assure you that my generations of investors will never investment in a GSE or Federal security as long as we live.
    Reply | Link to Comment
  •  
    Sep 07 07:24 PM
    Probably the best plan. Certainly the equity should lose. The US Treasury still doesn't guarantee Fannie and Freddie debt. The taxpayers have a chance to win.
    GSE debt should rise in price and financial stocks should have a significant rally when the market opens tomorrow.
    Reply | Link to Comment
  •  
    Sep 07 07:54 PM
    financial stocks should rally when the market opens.

    ain't that swell. anyone who buys financial stocks into this rally is looking to lose money.

    the financial system is broken." ---paul volker

    believe it.
    Reply | Link to Comment
  •  
    Sep 07 08:09 PM
    The thing he seemed to overlook is halting the stock. There's $40 Billion locked up right now that will be free to leave come 7AM tomorrow. That means shareholders will have the opportunity to cash out what they can before the stock goes to zero. It also means, with Common and Preferred drained, the companies will be $40 Billion in the hole. Sounds like $2 Billion is not quite enough to break even from where the companies are today. Who is going to buy into what is surely going to be many quarters of increasing losses when they know Hank has it set to drain the common and preferred to make up the losses? Not me. That bill is going to have to be passed on to the taxpayers now.

    How is this going to put confidence back in the GSE's and add liquidity to the failing financial market? The GSE's are hamstrung so don't look to them to take on loans anytime soon. No money, no hope for banks, no hope for a drop in rates, no hope for the housing market, no hope for recovery.

    Way to think this through Hank. I can't believe GS has continued to function while you've been away?
    Reply | Link to Comment
  •  
    Sep 07 08:55 PM
    Here is the opportunity of a lifetime for a new Quantum fund to break the dollar and make a name for itself for future generations...
    Reply | Link to Comment
  •  
    Sep 07 10:34 PM
    Saving the banks while sacrificing the tax payers.

    In the end, both with lay dead on the alter of fiat money; their blood pooling beneath them.
    Reply | Link to Comment
  •  
    Sep 08 12:28 AM
    the question now is how safe is it to hold equity in cos of similar significance and government interest ? isn't it likely that they too could be stripped of their rights as shareholders to protect the chinas and the pimcos? certainly paulson has learnt a lesson fron the bear stearns collapse ... if the shareholders are not going to have a say, no one can challenge the decisions announced this sun
    Reply | Link to Comment
  •  
    Sep 08 12:37 AM
    Why would anyone own stock in any bank (or airline, or automaker for that matter...) Gambling is gambling ... "You pays yer money, you gets yer chance...".. jegan
    Reply | Link to Comment
More Comments on FNM »
Top Rated Comment Streams:

Numbers are net rating-

See all Top 100 »
More by Brad DeLong

Investment Resources
Money Management
Research
Seeking Alpha provides these ads as a service to its leading contributors
Articles on related themes
Today's Market
Government Policy
Economy
Consumer Credit