Banks Take Bigger-Than-Estimated Hit on Freddie, Fannie Conservatorship

We have said more than once that a terribly misguided aspect of the Freddie and Fannie conservarorship was the elimination of dividends on the GSE’s preferred stock. Preferred was the best vehicle that struggling financial firms had for raising new capital. Eliminating the dividend lead to big losses in all financial preferred stocks, since investors assumed any bailout would similarly trash the preferred. Indeed, it is quite possible that this move accelerated Lehman’s demise, since it closed off its best funding option.

A second reason for taking a dim view of this move was that the Treasury had encouraged banks to buy Fannie and Freddie preferred stocks, so any losses on these holdings would reduce the equity of banks that owned the stock. Paulson alluded to the issue in his statement announcing the conservatorship, and claimed very few banks would be affected, and the impact would not be significant:

The agencies believe that, while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital.

It looks like they were wrong. From the Financial Times:
US regulators have underestimated potential bank losses on preferred stock issued by Fannie Mae and Freddie Mac, the American Bankers Association said on Monday.

Nearly a third of US banks hold preferred stock issued by the two mortgage financiers that were taken into conservatorship this month, according to an industry survey conducted by the ABA. The average bank exposure to such securities relative to core equity capital was 11 per cent.

“The negative impact on banks – particularly Main Street community banks – is far greater than regulators first thought,” wrote Edward Yingling, chief executive of the ABA in a letter to the Treasury, the Federal Reserve and other banking regulators.

The government takeover of Fannie and Freddie all but wiped out the value of $36bn of their preferred shares. This would force exposed banks to take writedowns at the end of the third quarter that could impede future lending, the ABA warned.

“When the actions were contemplated to reduce dividends on Fannie Mae and Freddie Mac preferred stock, the bank regulators estimated that only a dozen banks would be affected by it,” Mr Yingling said.

Regulators said this month only a small handful of banks had “significant” holdings in Fannie Mae and Freddie Mac relative to their capital bases and that they would help develop plans to restore capital at these banks.

However, the ABA survey suggests the impact of writedowns could be more widespread and more severe than regulators initially indicated, particularly among small community banks that engage in lending for small and medium-sized local businesses.

The ABA’s letter called for regulators to reconsider the suspension of dividend payments on Fannie and Freddie preferred stock to alleviate the capital impact on banks and avoid a multi-billion dollar decline in lending.

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  1. M

    It’s becoming clear. Paulson and Bernanke didn’t dissolve the preferred shares in FNM and FRE in order to save the taxpayer; they dissolved the preferred shares, after encouraging smaller regional banks to buy in, because they wanted them to go bankrupt or to sell assets for pennies on the dollar, in which case they will inevitably end up at Goldman Sachs.

    Here’s another hint:

    “Key changes in the guidelines include allowing an investor to buy up to a 15 percent voting stake instead of the previous 9.9 percent limit. Investors can also buy up to 33 percent total equity interest, including voting and non-voting shares, instead of the 25 percent prior limit.”

    This will allow private equity companies to own a larger share of a bank without being designated a “bank holding company” and falling under the supervision of the Federal Reserve.

    Bernanke and Paulson will screw over this country until it’s bled dry to save and promote their buddies on Wall Street, and NO ONE IS DOING ANYTHING. Man, are we screwed.

  2. Anonymous

    Totally agree, m. There are hidden agendas here, deep down where the sharks fight it out. These are not sudden short-term solutions quickly arrived at, especially since the fundamental problems have been known for a long time. Without necessarily donning a tin-foil hat, the possibility has to be considered that the future outcomes have at least been discussed in the past, perhaps as far back as when Paulson himself was at Goldman Sachs.

  3. eh

    First reaction: Gee, what a surprise that the decision-makers don’t know what the situation really is and also have no idea what the consequences of their actions will be.

    But the first (astute) comment may indeed be correct.

  4. elartistamadridista

    I don´t see how they managed to get that wrong. Didn´t they have acces to the registry to see who was holding the stock and in what amount? It looks pretty straightforward to me.
    Or maybe the american system is different in this too.

  5. Anonymous

    Or it may be the simple fact that
    Paulson et. al. are unable to
    put together a comprehensive plan.
    Reactionary, as seems to be the
    pattern of the executive branch.
    Shoot first and bury the innocent

  6. Anonymous

    With regard to the first post – well, you may be right, but then again, there is that old saying “never attribute to malice, what can equally be explained by stupidity”.

    The entire U.S. financial system is currently coming apart at the seams, and at the top you have a bunch of guys who are probably not the sharpest quills on the porcupine, and who are still desperately trying to stop that disaster from happening. They know full well that, given the potential for widespread, Depression-era misery, failure is simply not an option. Especially since in a worst-case scenario the expression of “their heads being on the block” might turn out to be a lot less metaphorical for them than anyone would want to contemplate right now.

    So anything you see happening might be part of a large, diabolical plan, or just an administration that is made up of individuals of very moderate abilities trying to something, *anything*, that looks like it could at least buy them some time.

  7. Anonymous

    When Paulson/Bernanke nationalized Fannie/Freddie and wiped out the preferred stock they made an announcement to the effect that ‘local/regional banks that were adversely effected by the wipe out should contact the treasury for relief’ (paraphrased).

    What happened to the relief? Has it been conveinently forgotten?

    I predicted, prior to the take over of the GSEs, that the long term goal was to bk local/regional banks and that the Wall St pirates would have these banks for pennies. This IS their new biz model, their reason for being.

    Since the Wall St pirates no longer have a large revenue stream from ‘financial innovation’ the regional/local banks will provide a replacement revenue stream.

    Paulson, with unlimited resources, exemption from rules and laws, and exemption from prosecution, will plunder any and all entities (banks) that are not ‘friends of Hank’.


  8. John

    For supposely such a smart guy Paulson is consistently wrong. It would appear there is a method in his madness, all part of the looting of America.

  9. Walther von Reinbach (spain)

    Nice piece at
    Don’t let the prospect of a national crisis trick you into giving up your freedom, America. The people behind this scam are the same landsharks and flim-flam men who polluted the global marketplace with their snake oil and toxic sludge. These are the fraudsters who manufactured the crisis to begin with. This is just the latest installment of the Shock Doctrine; engineer a crisis, and then, steal whatever is left behind. Same sh**, different day. Be resolute. Don’t budge. Our economic foundations may be crumbling, but or determination is not. This is our country, not Goldman Sach’s. The people who destroyed America must be held to account. Their time is coming. Justice first.

    By Mike Whitney

  10. Anonymous

    And still the ‘narrative’ in the main stream media builds around Paulson being competent. Yesterday, e.g., Chris Mathews exclaimed to all listening that he thanked God that Paulson was at Treasury. He is not alone. Even Josh Marshall yesterday described Paulson as competent.


    Everyone who reads this blog should be contacting every media person they know – indeed should be sending out emails to all who they know in general – to link to this post and other posts that demonstratively show that Paulson is not competent to lead toward any — ANY — resolution of this crisis. He may be a talented salesman. But that is not sufficient to the challenge at hand.

    And, by the way, it matters less whether he is venal or corrupt or stupid. The message that should be coursing through the media is that he is not competent to run this show. He has been singularly wrong every step of the way.

    And, for those who think the mainstream media will not listen, I suggest one thing is different this time versus Iraq etc: The media people themselves know they and their families are actually at risk.

  11. Anonymous

    Uhm, Chris Dodd called Paulson a ‘buffoon’ last evening, so I don’t think you’re correct when you say the mainstream media believes he’s competent.

    Just remember the old story; a toad offers to take a scorpion across the river. the toad is wary, but the scorpion assures the toad that he will not sting him. halfway across the river, the scorpion stings the toad. upon being stung the toad says, “WHY DID YOU DO THAT?” the scorpion replies, “i’m sorry, it’s what i do.”

    Would you throw a bunch of fish to a shark and expect the shark not to eat them because you asked him not to?

  12. Anonymous

    Come on guys, this quote is form the American BANKERS Association. That’s a lobbying group.

    Regardless, broke is broke and
    FNM/FRE were broke. How do you bk them without wiping out the undeserving shareholders and giving the debt holders a hair cut? In this case, the debt holders were made whole for two reasons:

    1. The CDS problem at FNM/FRE would have wiped out the system.

    2. FNM/FRE are the market for new mortgages.

    I doubt there was malice involved. I doubt that I doubt there was much choice other than let the system fail then and start over with new institutions. I’m actually disappointed in the quality of this article.

    That’s not to say that I think the Paulson plan is a good one or that he isn’t protecting his buddies to the best of his ability at this point. I just don’t think that’s where he was coming from when they took out FNM/FRE. Call me naive if you want.

  13. Anonymous

    anon at 8:30 Glad to hear Dodd called Paulson a buffoon. But with all due respect, if you monitor the AP, CNN, the 3 networks, what local papers and TV stations say, radio — in short, MSM as a whole — the battle is still on between “Paulson knows what he’s doing” vs. “Paulson is a buffoon”.

    So far, the first is winning.

  14. Anonymous

    We have said more than once ….. Freddie and Fannie conservarorship was the elimination of dividends on the GSE's preferred stock. ……. it is quite possible that this move accelerated Lehman's demise, since it closed off its best funding option.

    why help some and not all?
    what was lehman exposure to F&F if you assume is that important?

  15. Anonymous

    Anon at 8:40 AM:

    Who allowed and encouraged Fannie/Freddie to become the largest Mortgage buyers? Who allowed and encouraged F/F to purchase $Trillions of mortgages that were known to be toxic?

    If Greenspan/Bernanke and Paulson did not see this train wreck coming then they are definitely incompetent. If the trio did see the train wreck coming and did nothing to stop it then they are definitely conspirators in the financial destruction of the US and perhaps the world.

    You can’t have it both ways, even if you claim naivety. Since I don’t believe the august trio is stupid, I propose that they are destructors involved in a conspiracy.

    Where did I put that tinfoil hat?


  16. Anonymous

    I do monitor them…


    Liberals and conservatives generally dislike the plan. William Greider of The Nation writes: “If Wall Street gets away with this, it will represent an historic swindle of the American public — all sugar for the villains, lasting pain and damage for the victims.”

  17. kevin


    Your comment was quite prescient.

    It looks like they are going to split up WaMu and guess who will be first in line to gobble up the choicest pieces?

    Goldman Sachs.

  18. Matthew Dubuque

    Matthew Dubuque

    For those listening to the Senate hearings, I ask that they pay special attention to the upcoming eight minutes allotted to Senator Elizabeth Dole.

    Her opening statement was incredible, laying out the protracted history of criminal collusion between the thoroughly corrupt GSEs and their fat minions feeding at the trough in Congress.

    She of course comes from the great Kansas tradition that gave birth to the revolt of the Kansas City Federal Reserve Bank, led by FOMC Vice-Chairman Wayne Angell, against blind jihad monetarism and the subsequent conversion in the summer of 1982 of Paul Volcker to the rational fold. A rare success story in deprogramming.

    In terms of the GSE preferreds, the whole criminal enterprise of Fannie and Freddie was unspeakably corrupt and deeply steeped in deceit and fraud.

    And permeating the mix were those who “gamed” the system thinking they would escape from the subsequent fallout by simply owning preferred stock.

    I am delighted that the Fed insisted that such criminals take a serious hit in the teeth. You go Ben!

    The BILLIONAIRES need to pay as well.

    As for the community banks referred to by the ABA head in this post, I’m convinced that they will receive the relief they need.

    As for the others, let this be a prelude and a warning to those who launder billions in hedge funds and private equity that they are next in line.

    Matthew Dubuque

  19. S

    Paulson is an American first. For this I have no doubt and if I were heading into a fight I might venture to say I’d want him on my team. Malice or not, he is protecting the system he knows for fear of the unknown. Can’t blame him. What doesn’t get or doesn’t want to get is that what he defends is indeed the malignancy.

    Wall Street has undergone severe mission drift. Instead of being a conduit for transaction/innovation it has become its own profit center max extreme. Americans had an equal role in perpetuating this crisis via irresponsible behavior. However watching Congress and the sophomoric commentary makes it pretty clear that the level of financial sophistication in this country made the sheeple willing and easy targets.

    Everyone keeps talking about root causes and points to housing which completely misses the point. The root cause is the trade policy and Bretton Woods II. Not a single person other than Ron Paul, who may be wacky but is the only person with a reasoned understanding of the different economic levers at work, understands the root cause. The global financial plumbing is broken.

    The healthiest thing for the US economy in the long run is for Wall Street to be cut off at the knees.

    As an aside Bernanke is saying taxpayers should own assets at held to maturity value. Exactly what is the hold to maturity value when you have no idea what the inputs are (and all assumptions heretofore have been wrong). we are teetering on the brink of fascism.

  20. Anonymiss

    Anyone know where to find the text accompanying Meredith Whitney’s downgrades today? I’d be much obliged :)

  21. S

    higher credit cossts and cut numbers. Not as shock. Raise the NCO in the model hence lower numbers. nothing revolutionary there.

  22. Anonymous


    1) Dole is a GOOPER whore from North Carolina.

    2) Paul Volcker saved this nation in 1979.


  23. Anonymous

    I wanna know WHO is lining up with their palms up for the 700b boon?

    WHO are they who are behind B & P but who have no names (YET?)

    Disclosure should be to story of the day – FULL disclosure.

  24. Anonymous

    Goldman Sachs and JP MOrgan are the key firms behind this. Morgan Stanley is along for the ride.

    Bernanke should carry a JP Morgan id card and get discount meals in their cafeteria.

    Paulson probably still has his GS issued blackberry.

  25. doc holiday

    Everyone needs to remain calm, the plane has landed, although it is landing upside down and on fire; prepare to exit when we come to a halt. It must be God’s will for Goldman to be in the drivers set!

  26. Bob_in_MA

    Does that math work? “The average bank exposure to such securities relative to core equity capital was 11 per cent…. The government takeover of Fannie and Freddie all but wiped out the value of $36bn of their preferred shares.”

    So, assuming all the preferred shares were owned by banks, it would mean banks collectively have just $330B of core capital. Does anyone know if that’s in the ball park? Seems pretty low to me, but then I don’t know much about the subject.

  27. doc holiday

    Re: "Uhm, Chris Dodd called Paulson a 'buffoon' last evening, so I don't think you're correct when you say the mainstream media believes he's competent.

    >> I see nothing to back that claim up, it would be nice, but Dodd and Paulson work as a wrestling tag team, as with Bear Stearns, et al…

  28. Anonymous

    Kiran Chetry: You know talk about waking a sleeping giant — we have almost 2,000 blog posts on about this bailout alone. Many people are outraged about it. They feel the government is spending $700 billion or more to reward bad behavior. What can you do to assure people that this is the right thing?

    Sen. Christopher Dodd: Well, I’m not sure it is at this point. That’s why we’re having this hearing this morning. We’ll have Secretary Paulson and Ben Bernanke, the chairman of the Federal Reserve, before the banking committee to explain this plan, why it’s necessary and where we go from here. They basically have asked for a blank check of $700 billion for the next several years here to buy a lot of bad instruments out there in these institutions. See what power Paulson would have if the bailout is approved »

  29. Anonymous

    These accusations that Paulson is ‘stupid’ are becoming disconcerting. It is the last refuge of the failed rheotorician to accuse his or her opponent of lacking intelligence. Paulson is obviously not stupid. He is **inexperienced**. If he were stupid, I fear we would have to develop new adjectives to describe the 99% of the human population that is less intelligent than he is.

    This is not a defense of Paulson, whose inexperience in macro issues and in government life is really damaging this country. Neither is it even a plea for civility. It is just a request to bring the level of discourse to a place where constructive ideas are not diminished by poor technique.

  30. Anonymous

    anon 12:42

    How else other than ‘stupid’ would you describe a Tsy Sec who talks about ‘hold-to-maturity’ values?

    What is the ‘hold-to-maturity’ value of receiving with certainty $100 in 30 years. It certainly isn’t $100.

    What is the “hold-to-maturity’ value of receiving either $100 or $10 in thirty years. That surely isn’t anywhere near $100.

  31. Anonymous

    Sherman writes…

    Ok, there are so many knowledgeable people on this blog, perhaps someone can offer me some insight. I’m not trying to be inflammatory, I just am trying to get some sort of grasp on the situation:

    -Our monetary system is based on debt. With so many debts being defaulted on left and right, doesn’t this mean a corresponding contraction in the money supply? In this way, these “inflationary” bailout measures will not really cause inflation, but rather, will prevent massive DEFLATION, right? I don’t know if investment bank assets were ever part of the money supply, but if they were, then there will be a structural decrease in the amount of money that can be pyramided off of every M0 dollar, as formerly 25x-30x leveraged iBanks now become parts of 10x leveraged commercial banks. The demise of the unregulated investment banking industry will decrease the amount of leverage in the ecnonomy, therefore decreasing the money supply, right?

    In brief, aren’t these bailouts necessary simply to prevent massive deflation? Or is there anything wrong with massive deflation? maybe there’s not…

    I’m looking forward to learning from your responses!

  32. Anonymous

    Bottom line:

    if there was any long-term value in these ‘assets’ than that value should be strippable and sold separately.

    if there was any long-term value in these assets do you think for a moment GS or MS would foist them on the taxpayer?

  33. Anonymous

    The ‘bailouts’ are only necesary to keep GS and MS and possibly JPM from going broke.

    Let them go broke, let the bond holders fight over the remaining assets.

    the only the we have to fear is bush himself.

  34. Lockstep

    People, let’s get back to the topic at hand. Can the banks make it without reinstating the Fannie / Freddie dividends? A many will, many will not. But we have not even heard the uproar that overseas investors had privately regarding the suspension of those dividends. Let me be up front, I am biased because I bought the preferreds opportunisticly ahead of the decision. But it was because it is obvious that capitalization of banks globally is in such a precarious state that socking the preferreds would force another round of huge writedowns all over the system.

    Reinstate the dividends and start the healing process.

    Disclosure: Long FRE/FNM preferreds, Not Long (Can’t say short any more) All Financial Stocks

  35. Lewis B. Sckolnick

    Without the reinstatement bigger banks will get bigger and smaller banks will disappear. MS GS JPM will remain in place no matter what they want to call themselves.

  36. ScottH

    If it looks like this rescue is not going to get passed in time, I expect that Bush will declare a National Emergency and assume control of the country under several of the executive orders he has signed over the years.

    Sounds extreme, but if the alternative is scorched earth and hungry, very angry crowds descending on gated communities … well, it may be necessary.

  37. Anonymous

    September 23, 2008

    Hot off the press 11:20 AM PDS:

    “Bernanke, putting aside his prepared remarks released earlier today, said the Treasury should buy illiquid assets at “hold-to-maturity'' values rather than at discounted “fire- sale'' prices. The suspension of “mark-to-market'' accounting for assets, a change backed by “many banks,'' would instead hurt investor confidence.”


  38. ScottH

    “Bernanke, putting aside his prepared remarks released earlier today, said the Treasury should buy illiquid assets at “hold-to-maturity” values rather than at discounted “fire- sale” prices. The suspension of “mark-to-market” accounting for assets, a change backed by “many banks,” would instead hurt investor confidence.”

    I guess it depends on how long “maturity” is and how you define that and other features of CDS, CDO and their brethren. $100 today is not the same as $100 two years from now, even discounting at the risk-free rate for that period. The longer the maturity, the worse it gets.

    Lehman’s toxic waste is trading for less than 20 cents on the dollar. I think Bernanke and Paulson are proposing 100 cents on the dollar. That is categorically NOT going to be recovered on eventual sale of the assets. Much of the paper will simply expire worthless. I think that is the plan – to take all the derivative toxic waste off the table and hope that it doesn’t net out too bad. If it nets out very poorly, or is allowed to expire worthless in its entirety, expect that to be buried for as long a period of time as possible.

  39. Anonymous

    I invest in small-ish banks — supposedly — for a living. Relatively few public banks have been catastrophically affected by losses on Fannie/Freddie preferreds. But a great many have experienced losses at a time when capital could not be more precious.

    Unintended consequences are the rule these days.

  40. Anonymous

    With regard to preferreds, Buffet just stepped up for $5B in 10% perpetuals with a 10% premium callout from Goldman — with $5B more of warrants with a $115 strike.

    So, clearly the market for preferreds isn’t dead if the deal is deemed to be solid. Of course, it may require a bit of additional backstopping to get done. :)

  41. Tim

    Goldman to Raise $7.5 Billion

    Published: September 23, 2008

    The investment bank, Goldman Sachs, plans to raise $7.5 billion in fresh capital by selling $5 billion in perpetual preferred shares to Berkshire Hathaway, the conglomerate run by the billionaire investor Warren E. Buffett, and issuing $2.5 billion in common shares, according to a Goldman spokesman, Lucas Van Praag.

    The move comes after Morgan Stanley on Monday raised about $8 billion by selling up to a 20 percent stake to Mitsubishi, the Japanese bank. Both Morgan and Goldman Sachs on Sunday transformed themselves into bank holding companies in an effort to broaden.

  42. Wendy

    I agree that we all need to scream at the top of our lungs at anyone with any power over this that we are NOT going to stand for any of this mess.

    I am a regular reader (several times a day I read this blog) but I am not articulate enough in these matters to post nor do I have the required knowledge to write a letter to any senator or congressperson that would contain a clear enough message.

    I am sure there are others like me, in fact I am sure because I have recommended this site to numerous people whom also love it but are in the same position I am.

    Would Yves or someone else capable be willing to write a statement that we could copy and send with our name attached to senators, congress, president, secretary, heck I’ll send one to my barber if it will help!

    This is utterly terrifying. We are watching our country, freedoms, liberty and rights come apart at the seams and it is not a straight cut. It is a jagged one that will take some time to repair and longer to heal and will leave a huge scar for all of time.



  43. h2odragon

    “limited understanding” is no excuse for not communicating your opinion to your elected representatives. Tell them straight up, if you feel the need, “as far as i can understand” or similar; but tell them so they have some chance of doing their jobs properly.

    Of course that’s only if you think they’re interested in doing their jobs, and that the “rule of law” is still a goal worth effort, not a lost dream.

  44. Wendy

    Thank you so much Yves.

    It’s not that I would not say something it’s just that I feel my voice would be better heard and hold more merit if it sounded more professional than I may have been capable of doing on my own. I hope I did not give the impression that I would do nothing due to “limited understanding”. Quite the opposite, I simply wanted my opinion to be able to carry as much weight as it can and if you sound like you don’t really understand the situation I don’t think you are taken as seriously.

    Thank you Yves. I will use this information and share it with others. I appreciate your time.(And your amazing blog!)


  45. Richard Kline

    A third of US banks take an _average_ 11% loss to core capital on this?? That’s a major ouchie. If Paulson did not have that information with going on fifteen months to prepare, he’s beyond an ass. If he’s dissembling, he’s worse. Incompetence is a required (in)capacity for a member of the Bushies’ Inner Ring (gotta fit in with the boys, right?), but this guy is putting a new slope on the graph of that equation. *yeesh*

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