Comments on: Paulson Playing Chicken With Markets: Guess Who Will Win? (GSE Edition)

By: lyubomira5

lyubomira5 — Thu, 21 Aug 2008 00:29:00 +0000

Both FNM and FRE are insolvent at this point. In addition to not getting enough interest payments from mortgagees, they have recurring expenses like foreclosures (a foreclosure can cost up to $50,000 before it is all said and done), delinquent real estate taxes (which have to be paid since they are a higher priority lien than the mortgage). Add to that the declining value of collateral. They have a negative cash flow.

Obvious options are:
- chapter 11 bankruptcy protection from current creditors;
- take over of the shares by the US government (which shares IMO are worth $0.00 even though they are still trading above that);
- the US explicitly guaranteeing future debt and becoming first position bond holder for both (in front of all other bond holders).

Over time borrowers will pay some o the debt, foreclosed property values will recover and this excercise can become profitable for the US as was the RTC (it did turn eventually a profit).

The immediate concern, in Bernanke's words is the triangle of risk, liquidity and capital. And the low interest rates will of course help stabilize things as treasury paper holders realize that treasury rates even at 4% and inflation of 5.6% means investors are losing 1.6% every year in real terms.

By: Chris

Chris — Tue, 19 Aug 2008 23:35:00 +0000

esb

Obama needs a reading list on bank holiday(s)

By: esb

esb — Tue, 19 Aug 2008 16:33:00 +0000

Paulson kicked the can into the air in July.

It is still in the air.

He thinks it will remain in the air until after the inauguration (of Obama) at which time it will come crashing down on his not-so- well insulated head.

He is probably right.

I have great sympathy for Obama, who will be entering into an office stuffed wall to wall with financial C4.

By: Chris

Chris — Tue, 19 Aug 2008 16:18:00 +0000

Aren’t there kind of gross political time considerations in these kind of things? Now till the conventions, Labor Day to the Elections, elections to inauguration. Sometimes the name of the game is just to kick the can down the road. If they can’t get it into the next guy’s watch in one big kick, just keep it moving forward with little kicks, and hope nothing too bad happens. All a question of avoiding blame and accountability and dumping it in the lap of the next lot. Is there still time to buy more time?

By: Anonymous

Anonymous — Tue, 19 Aug 2008 15:43:00 +0000

Let's see, I can hazard a few ideas as to how to proceed that might stick.

1. The GSEs operate pursuant to a Federal charter. The spreads the markets demand for their MBS is now putting their ability to perform their role as envisioned in the charter in jeopardy. Pulling their charters would put them out of business. That is not the simplest or most straightforward way to force GSE shareholders to accept being wiped out, but it would stick. No charter, no GSE.

2. Both firms are regulated entities. Regulated financial institutions operate at the suffrance of their regulators. They have considerable authority to shut down their charges or force liquidations. I am not sure how far OFEHO's powers go, but look what OFHEO did in reaction to the accounting scandals, and their intervention was comparatively mild. I don't see any reason to think that OFHEO has less power than other banking regulators.

Freddie is already operating with negative net worth on a mark-to-market basis. I have read things elsewhere that suggest that that puts it in violation of its operating requirements. Declaring FRE insolvent (or threatening to privately to force management to play ball) is a no-brainer. I am sure that Fannie is close enough to being out of bounds that it too could credibly be deemed to be insolvent, or at risk of being insolvent (reversing the deferred tax treatment alone puts them in negative net worth territory) to justify intervention.

By: Anonymous

Anonymous — Tue, 19 Aug 2008 15:28:00 +0000

Not to get all ’strategery’ on you, but maybe Paulson **wants** us to think it was a bluff, because he always knew he would have to bail the two out. He wants to look like he exhausted all options (even a bluff) and then, lo and behold, was actually ‘forced’ into the bailout. A large contingent of taxpayers are going to be furious about bailing out bankers (including foreign central bankers). Isn’t Paulson’s paramount need here to look like he resisted this for as long as possible?

By: Anonymous

Anonymous — Tue, 19 Aug 2008 15:26:00 +0000

Wiping out the shareholders of Fannie/Freddie would trigger the financial collapse that was avoided by the Bear Sterns bailout. Some very large public agencies have billions invested in the GSE’s stock because they can only invest in government securities and bonds (backed by the full faith of the Us Gov’t. Even Greenspan says the guarantee is there even if disclaimed.). Some very large pension plans also have billions invested because even the most sophisticated investors viewed them a super safe. These would all collapse almost overnight if their investments were wiped out. The ripple effects would trigger the domino effect predicted had Bear Sterns collapsed.

By: maynardGKeynes

maynardGKeynes — Tue, 19 Aug 2008 14:25:00 +0000

Big question out there: Is it clear that Paulson has the power in the first place to seize the GSEs (i.e., by wiping out equity holders through forced issuance and subsequent purchase by the government of preferred or other senior share classes), even if he wants to? People point to the recent recent legislation as giving him this power, but insofar as the legislation purports to authorize confiscation, it’s probably unconstitutional. Under the US Constitution, the government may seize private property for public use in one way and one way only — through the eminent domain process specified in the eminent domain clause of the Constitution. Indeed, Is anyone aware of the federal government EVER having seized a private company (other than an FDIC or FSLIC bank) in peacetime? As far as I can recall, the Chrysler bailout did not wipe out shareholders. In the case of the FDIC, the banks are private, but the FDIC insurance agreement explicitly provides this right of seizure. Bottom line is that the GSEs have NOT failed nor are they insolvent under US law. Unless that scenario changes, I doubt that they can be seized, except through the eminent domain power, which is quite cumbersome and too time consuming to provide the rescue in time to save the GSEs.

By: Stuart

Stuart — Tue, 19 Aug 2008 14:02:00 +0000

AND , yet they won’t let Morgan look at the REAL books. Go figure that one .. ??! It all screams another sham.

By: S

Tue, 19 Aug 2008 13:48:00 +0000

The fair valeu balance sheets are a sham. The entire excess capital is tied to def tax assets. Those are not fungible. hence they are effecietivly bankrupt. Excess capital is a sham measure. LEH hgas assured the markets every quarter that it has sufficent capital and yest has been reduced to talk of selling NB crown jewel.

The notion that China was ever going to open its capital markets to the US was lunacy. It is shameful that Washington negotiated itself into a cul de sac for the past few decades. Now we have approx 0 leverage. tactics without strategy the surest way to defeat. Typical short termism in the USA. The Putin gambit kind of tells the story. The US has been reduced to talking tough and well talking tough (unless you are a third world/rate army).

Hey, at least the US has convicned the GCC to maintain the pegs. One success. $ backed by black gold.