The Times appears to have broken the story (hat tip reader Saboor) that the Treasury is seriously mulling an emergency cash injection into the troubled mortgage giants Fannie and Freddie in the form of some sort of senior equity (the article is not clear on this point, but the Wall Street Journal had mentioned a similar idea, a preferred issue that would be designed to dilute common shareholders).
If this unsourced report proves accurate, it indicates how serious the situation is. The immediate test is a scheduled Monday $3 billion short-term debt sale by Fannie (the Times article has a confused description in a section I chose not to include) . If that were to go well, it would alleviate some immediate pressure. And one would think it would not be all that hard for the Fed and Treasury to place a few calls and suggest that supporting this fundraising might be in everyone’s best interest. The move to more drastic measures is not a good sign.
And let us not kid ourselves: this is a fig leaf, not a solution. This move would acknowledge that the GSEs are undercapitlized without giving them enough equity to function as independent, self-supporting financial institutions. It affirms the implicit guarantee without formalizing it. It is a creeping nationalization that leaves management in place and provides no improvement in accountability or oversight. And it fails to resolve the ambiguities that created this problem in the first place: the GSEs are expected to operate like independent, profit-minded financial institutions yet serve collective aims. Indeed, this non-solution solution may have the unintended side effect of encouraging Congress to make yet more demands of Freddie and Fannie to rescue the housing market since they are now arguable stronger and adequately capitalized, and thus precipitate another crisis of confidence in even shorter order than would otherwise occur.
This plan would be entirely in keeping with Willem Buiter’s description of Comrade Paulson as a promoter of dishonest socialism and excessive support of real estate.
But this sort of measure would be entirely consistent with one of the Bush Administration’s prime objectives: to kick as many cans down the road as possible so they become the problem of the next regime.
From the Times:
US 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 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 US government would receive a new class of shares in exchange for the capital, which would be hugely dilutive to shareholders.
The potential rescue comes as investors are braced for more bad news from the financial sector. Citigroup is expected to reveal further writedowns of at least $8 billion with its second-quarter results, and Merrill Lynch is forecast to reveal writedowns of some $4 billion….
The capital injection would also see both lenders granted permission to use the Federal Reserve’s discount window – a short-term emergency funding source…
Some in Wall Street believe a rescue plan may be announced ahead of tomorrow’s US market opening to calm nerves and support the debt auction.
Howard Shapiro, a Wall Street analyst at Fox-Pitt Kelton, said: “I think it will happen over the weekend. There will be government action but it will be far short of the dire scenarios that people are envisioning.” He said there was “no question” that the two firms were fundamentally sound.
He added that Paulson would have to move in order to “change the psychology” of the market and put Fannie and Freddie back on a stable footing.
David Buik, partner at BGC Partners, said: “These agencies are the backbone of financial society in the US. They simply cannot be allowed to fail, and the government won’t allow them to fail. Whatever the solution is to this problem, I can’t imagine it will be good for shareholders.”
He added: “In London we may see a dead-cat bounce on Monday, especially if we get a rescue. But that’s all it will be – shares may pop up 50 points or so, but then they will head down again.”….
Robert Parkes, UK equity strategist at HSBC, said: “It’s a seller’s market – we’re generally advising clients to sit on the sidelines until all the current issues blow over.”