The New York Time reports that the Federal government is leaning towards conservatorship as the approach for handling Freddie and Fannie’s shaky finances. Under this scenario. shareholders are wiped out and taxpayers fund any losses.
What I find disturbing about the mainstream media coverage is the refusal to connect the dots between the increasing demands placed on the GSEs by Congress and the negative reaction in the market. This is pushback, pure and simple, against efforts to finesse a Federal bailout of housing by pushing as much as possible on to Fannie and Freddie, rather than set up new programs so the costs would be explicit.
There are no free lunches, particularly in times like these.
From the New York Times:
Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday…..Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.
The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.
Yves here. So the Feds believe that the markets can be fooled by off balance sheet financing. Back to the Times:
The officials also said that such a step would be ineffective because the markets already widely accept that the government stands behind the companies….The officials involved in the discussions stressed that no action by the administration was imminent, and that Fannie and Freddie are not considered to be in a crisis situation…..
Under a 1992 law, Fannie or Freddie could be put into conservatorship if their top regulator found that either one is “critically undercapitalized.” A conservator would have sweeping powers to overhaul them, but would not have the authority to close them….
In recent weeks, the companies have spiraled downward, undermined by declining confidence in their future and shaken by sharp declines in their assets as the housing markets have continued to slide and foreclosures have risen.
In the last week alone, Freddie has lost 45 percent of its value, and Fannie is off 30 percent. Expectations of default at the companies have also risen; it costs three times as much today to buy insurance on a two-year Fannie bond as it did three years ago.
Analysts expect the companies to announce a new round of write-downs and possibly be forced to raise capital by issuing additional shares, which would dilute their value for current shareholders.
Despite repeated assurances from regulators about the financial soundness of the two institutions, financial markets have concluded that by some measures they are deeply troubled.
Freddie, for instance, is technically insolvent under fair value accounting rules, in which the company puts a market value on assets as if it had to sell them now……
Although Treasury Secretary Henry M. Paulson Jr. and Ben S. Bernanke, the chairman of the Federal Reserve, passed up invitations by lawmakers on Thursday to seek legislation to deal with the crisis, officials said that the administration had been privately considering a government takeover should the markets continue to turn against the companies….
At a hearing of the House Financial Services Committee on Thursday, both Mr. Paulson and Mr. Bernanke were guarded…
Neither official would address a question posed by Representative Dennis Moore, Democrat of Kansas, who asked whether the failure of either institution would pose a risk to the financial system.
“In today’s world I don’t think it is helpful to speculate about any financial institution and systemic risk,” Mr. Paulson said. “I’m dealing with the here and now, and the important role that they’re playing and other financial institutions are playing.”
So Paulson couldn’t even muster a convincing lie, and ducked the question clumsily. That give you the answer right there.
Update 4:40 AM: Further discussion:
Fannie and Freddie Waterfalls Are Too Big to Bail Michael Shedlock
NYT: Freddie/Fannie Takeover Talks Heat Up. Voom Needed Paul Kedrosky
In Large, Red, Friendly Letters it Reads, “Don’t Panic!” (GSE Edition) David Merkel
Anonymous 
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They won’t speculate, because the thought of FNM or FRE failing is just to catastrophic to think about. Think about it. The failure of Fannie and Freddie would essentially render the U.S. government insolvent.
Yves, I hope you’ll address more the ramifications of these two failing for the market, the economy, and the world as we know it.