Fannie, Freddie to get $15 Billion from U.S. government

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The Times of London is reporting that Treasury Secretary Paulson is looking to infuse Fannie and Freddie with $15 billion to help alleviate market turmoil. However they cite no sources in doing so.

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Moreover, the $75 billion offered by Lehman Brothers which started this crisis is much closer to the amount of capital needed by the two companies in order to shore up their balance sheets. With over $5 trillion in assets, a loss of only 1% on that asset base would mean more than $50 billion in capital writedowns.

If Paulson thinks he can get away with this band-aid step to stop the bleeding, he he will be disappointed by future events and will be forced to revisit more draconian solutions down the line. While this solution does not reward current shareholders, it fails to address the significant losses already in place on Fannie and Freddie’s existing mortgage portfolios.

U.S. Treasury secretary Hank Paulson is working on plans to inject up to $15 billion (£7.5 billion) of capital into Fannie Mae and Freddie Mac to stem the crisis at America’s biggest mortgage firms.

The two companies lost almost half their market value last week as rumours of a government bail-out swept the stock markets, hammering share prices around the world.

Together, the two stockholder-owned, government-sponsored companies own or guarantee almost half of America’s $12 trillion home-loan market and are vital to the functioning of the housing market.

The capital-injection plan is said to be high on a list of options being considered by regulators as a means of restoring confidence in the lenders. The move would protect the American housing market, but punish shareholders in both companies.

Under the terms of the proposed move, the U.S. government would receive a new class of shares in exchange for the capital, which would be hugely dilutive to shareholders.

Times of London, 13 Jul 2008

This solution has not been confirmed by the Treasury. Nevertheless, it will not work. In my view, it’s only a matter of time before nationalization comes along. But, in nationalizing these two, the government should allow the existing bonds to lose value commensurate with the actual losses on the underlying collateral in the marketplace.

This will mean a complete loss for shareholders and a haircut of maybe 3, 4, 5% for bondholders. Any other solution is using taxpayer money to fund shareholders and bondholders. Fannie and Freddie are ostensibly private companies with an investor base that is fully aware of the risks of investing.

But for years, investors have acted like Fannie and Freddie securities are Treasury securities. They are not. Look through your mutual fund holdings right now. I guarantee you that your mutual fund’s U.S. Government Bond funds are invested in GSE paper. Whenever I have looked through mutual fund bond holdings, I have looked to see if they had been calling GSE paper treasurys. One such fund, I was forced to exit las year in anticipation of the problem we are seeing now.

The long and short of this is shareholders should get near nothing just as Bear Stearns shareholders were forced to do. More than that though, bondholders should suffer the losses they deserve for treating these companies like government entities. They are not. To reward these investors, many of whom are large companies and foreign governments at taxpayer expense is theft, plain and simple.

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