Freddie, Fannie Nail-Biting Continues

Another day of nervousness and not-exactly-positive developments on the Fannie and Freddie front.

What is remarkable about the situation now is that at least some of the trouble elements were entirely predictable, which suggests that a bit of aforethought might have led to a better plan and less bad outcomes (I’m not such as optimist as to believe that there is a good outcome available. This is an exercise in damage containment).

Let’s look at two elements that were obvious:

1. There was never such a thing as a limited commitment to rescuing Freddie and Fannie. The Administration could have floated a trial balloon on a shared pain option (an idea that Nouriel Roubini suggested, but admitted was just about certain to be a non-starter) of having taxpayers, creditors, and shareholders all take some hits on any Freddie and Fannie losses. But an unspecified commitment to helping the GSEs is tantamount to an open-ended commitment (we likened it to escalation in Vietnam: it may be sold to the public as incremental, but the reality is that it has the potential to be a bottomless pit).

2. Lack of a real program would not work in the long run. Frankly, I am amazed that the Administrations’ hand-waving-in-lieu-of-a-plan worked as long as it has. As we noted:

Treasury Secretary Paulson makes a statement which presents in the vaguest possible terms a plan which falls far short of a remedy for the GSEs. These measures merely serve to stabilize the patient; there is no, zip, nada acknowledgment that major surgery is needed.

Consistent with #2, we learned yesterday that Paulson fantasized that he could simply get some mechanisms in place that might make a certain amount of support for Freddie and Fannie possible, but never use it. That just isn’t going to prove to be sufficient. The GSEs are undercapitalized and need a real program to remedy that, not just empty promises from management (who never took the need for more equity seriously until a gun was put to their head) and the Treasury. But yesterday, we noted at some length, the Administration wasn’t even willing to make the right noises. In fact, the Wall Street Journal reported that the Treasury had hired Morgan Stanley to analyze options for the GSEs. Wasn’t the time for that before legislation was passed?

I suppose the Bushies thought they could kick this can down the road to the next Administration, but that isn’t going to succeed. A five-year Freddie note sale got done at record high spreads over Treasuries. And before you say, “Well, it got done,” one of the rules of Wall Street is almost everything can be solved by price. Illiquidity is often tantamount to “the seller can’t stand the bid,” as opposed to a complete absence of buyers (although there are market free falls when there are no bids or gross order imbalances).

Consider what the Wall Street Journal had to say about the offering:

Freddie Mac was forced to offer unusually rich terms to investors in a $3 billion auction of its debt…The company….had to pay hefty interest rates. The five-year notes were priced to yield 4.172%, or 1.13 percentage point above yields on safe Treasury notes, the highest “spread” Freddie has ever paid on such debt.

John Jansen at Across the Curve gave a more detailed account:

Notwithstanding the relative success of the Freddie sale the agency market is still a very troubled venue. One analyst notes that central bank demand for the sector has diminished significantly since June. He said the change in appetite could not be narrowed down by geography or by the asset size of the institution.

There are some outright sellers, some who just do not add or do not replace as paper rolls off and there is a group of first time buyers. On balance, however, central banks are buying considerably less of this paper.

Some are troubled by the recent statements of Secretary Paulson that he is not eager to use his new powers. Some have extrapolated from his statements that he is only prepared to exercise his powers in an emergency. What constitutes an emergency?

Suppose we walk in tomorrow and Freddie or FNMA can not get rolled over in the discount note market. Treasury exercises its powers and the taxpayers have an ownership interest in the GSEs.

The central banks are anxious for a resolution or some clarification. On the other hand Paulson would probably be happy if the stocks run close to zero and he never has to spend a penny. As long as they open for business each day he is likely to be a contented former partner of Goldman Sachs.

The New York Times reported that crucial foreign interest was flagging:

Even with Freddie Mac’s debt promising investors a rich return, overseas demand for the issuance was weaker than in the past. Asian investors bought about 30 percent of the debt, while Europeans took 10 percent, according to a person familiar with the offering. By comparison, for the 12 months leading up to July, Asian investors accounted for 36 percent of the company’s debt and Europeans held 15 percent, according to data released by Freddie Mac.

And Bloomberg indicated that this pattern showed itself in a previous sale….

Fannie paid a record high yield in a $3.5 billion sale of three-year benchmark notes last week that drew less demand from Asia. Investors in the region bought 22 percent of the offering, almost half the demand of three months ago and about two-thirds of Asia’s usual purchases.

“The 22 percent of Asian participation is worrying,” said Ajay Rajadhyaksha, the head of fixed-income strategy for Barclays Capital in New York.

…and argued that the sizeable funding requirements before the end of the quarter may force a rescue:

Fannie Mae and Freddie Mac’s success in repaying $223 billion of bonds due by the end of the quarter may determine whether they can avoid a federal bailout….

Rolling over the debt “is the single most important factor to their ability to remain liquid,” said Moshe Orenbuch, an analyst at Credit Suisse in New York. “So far, they’ve been able to do that.”…

“This whole backstop mechanism was set up so the actual need for it could be avoided,” said Mahesh Swaminathan, a mortgage strategist for Credit Suisse in New York. “The market is testing the Treasury’s resolve.”

There is a third problem with the Treasury plan which we confess we did not foresee but is blindingly obvious once pointed out. From the Journal:

Meanwhile, Freddie’s ability to raise capital, and therefore avoid a bailout, is constrained by the uncertainty created by the government’s deliberations, according to people familiar with the matter. Investors are unlikely to buy new Freddie shares if they fear the government might mount a rescue that would hurt the value of those shares. Freddie executives are due to meet with Treasury officials Wednesday to discuss the situation and the two sides may explore whether the Treasury could clarify its intentions in a way that would reassure investors.

A rescue, in other words, almost certainly means that equityholders will be wiped out. Thus the company must persuade investors that its capital-raising is sufficiently large so as to preclude a rescue. Given that more losses are certain to be in the offing, it’s well nigh impossible to instill the needed confidence.

One investor interviewed by the New York Times suggested a solution:

Others, including Bert Ely, a financial consultant and long-time critic of the companies, say the best option is for policy makers to buy debt issued by the companies directly. Guaranteeing or buying shares in the companies, by contrast, could expose the government to big losses if more mortgages default.

“In the short term they want to avoid an equity investment, and if they can avoid doing that they will,” Mr. Ely said.

Haven’t we seen a version of that movie over at the Fed?

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  1. Anonymous

    ‘Meanwhile, Freddie’s ability to raise capital, and therefore avoid a bailout, is constrained by the uncertainty created by the government’s deliberations, according to people familiar with the matter.’

    I cannot believe that Tresury Sec ‘strong dollar’ Paulson did not see this near term problem when he initally announced that the US will bail out the GSEs. Perhaps Hank wanted to insure that the GSEs fail? The only other possibility I see is incompetence on the grandest scale…but, after the last seven years, why would I be surprised by one more error? The wheels are falling off everywhere I look.

    Can we expect competence from the next group? I am not seeking brillance, merely competence.


  2. don

    Do I understand this correctly: the GSEs and Treasury must convince investors that a bailout won’t be necessary by convincing investors that said bailout will take place if necessary?

  3. Anonymous

    Why do you keep saying with so much certainty that the GSEs are undercapitalized? What do you base that on?

  4. Francois

    “Can we expect competence from the next group? I am not seeking brillance, merely competence.”

    Latest polls have McSame gaining ground on the Barrack Attack. Which goes on to prove that negative ads works, he may win, and no! with Phil “Mental Recession” Gramm as the next Treasurt Secretary, merely competence is not an option.

    “Do I understand this correctly: the GSEs and Treasury must convince investors that a bailout won’t be necessary by convincing investors that said bailout will take place if necessary?”

    Don: The only thing investors care about is their profits. Bailout, rescue, and what have you does not perturb them, as long as their pocketbooks is not affected. That is what the Treasury has to do: persuade them it will only affect “the others” a.k.a. you and me, the taxpayers.

  5. dd

    When the next administration opens the SS “lockbox” it will not find “worthless” Treasury bonds but totally worthless GSE debt, OTC derivatives liabilities and Level 4 “assets.” Current SS surplus (approx 2 trillion) should just about cover the losses and save the favored banks from insolvency.
    Who said these guys don’t know how to plan? If they couldn’t privatize through the front door then why not sneak in the back?
    Mission accomplished.

  6. Anonymous

    DD, it is absurd to suggest GSE debt will be totally worthless. You think all the housing backing that debt will be worthless?

  7. Unsympathetic

    Anon@10:14: Yes.

    Your investment is worth only what someone else will actually pay for it – nothing more, nothing less.

    Instead of whining about my lack of faith, you show me the buyers for Countrywide’s houses that are not included in their list of nationwide unsold REO.

    Worthless things have no price at which someone will purchase them. Those homes have no buyer. They are, therefore, worthless.

  8. Anonymous

    DD, the vast majority of mortgages are still being paid off every month. For GSE debt to be worthless, it is not just some houses excess houses built in the last few years that have to be “worthless”, it is the vast majority of housing in the US. You may as well also believe that the Dow should be at 0.

    In any event, you are silly to say that there is no price at which homes will be purchased. I will buy for $1 every home you can find for me where the seller – including CFC – wants to sell and there are no other buyers.

  9. Anonymous

    Unsympathetic, you say an investment is worth only what someone will pay for it. That is naive. It may be true for paintings and baseball cards, but not for investments that generate cash flows. If the mortgages underlying a security are performing, it does not matter what price the house might fetch in the market. I don’t know about you, but I am still living in the same house I have lived in for the last 10 yrs, and it doesn’t make much difference to me that I cannot sell it today for what I might have sold it for 2 yrs ago. My kids still enjoy the yard just as much as they did then, and I still get the same good night’s sleep under the roof. If my mortgage is behind a bond, and that bond is worthless, I’d like to buy it, get out of my mortgage, and start receving the payments of all the other people like me whose mortages are in that bond.

  10. Anonymous

    Anon 10:38 – you are naive. There are plenty of homes located in blighted areas without a bid. They are falling apart: mold, termites, abandoned neighborhoods, destroyed tax base, inability to service basic local infrastructure etc etc.

    A $1 basis won’t begin to cover the “negative value” these properties represent. Bulk sales are occurring in part because sophisticated buyers understand that many of these properties have to be torn down, and that some of these communities will take years to recover. Those bulk sales are counting on the “average” value of the portfolio to justify the expenses associated with the “left tail”.

    Worse than you think.

  11. Anonymous

    diabolus ex machina

    It will take some time til we find out if say Rumsfeld,Gonzalez and now Paulson were given a free hand or if Bush were the puppet master. I think the latter. During the hearings where Paulson presented his bail-out request I thought him very uncomfortable. At first I thought him just angry at being questioned. But later it occurred to me that like Peter Lorre in “Maltese Falcon” he was forced to sweat out a stupid story.

    History is replete with tales of Playboy sons who fritter away the fortune Daddy had amassed. We see a symmetry of fame and infamy. GWB seems to fit this picture well. Unfortunately for us the USA was Daddy’s fortune.
    If there is truth to this idea and there is a possibility of a Gotterdamurung then you can apply it to the economy much better then I.

  12. doc holiday

    Re: They haven't offered anything and we haven't asked for anything," Fannie Mae CEO Daniel Mudd said in a public radio interview Wednesday morning. "I don't anticipate that they will do that."

    >> I don't understand all The Covered Bond foot dragging here, in regard to bailing these crooks out and being able to carry out the vision to roll synthetic debts into new repackaging vehicle which will bear new improved colors and features that will stun an amaze even the slowest of muni investors, who chase yields, as they seek high quality ratings (above AAA) on securities.

    It is within the structure of Covered Bonds that Fannie, et al will be able to loosen the shackles of misrepresentation, accountability and fraud. It is within the structures of derivatives that the true basis of reward shall be found, as this is where the core of compensation structures can be linked to improved derivatives that will be linked to new FASB rules that will help in aiding and abetting methods to escape detection. These people that help underwrite and engineer American banking practices are doing the work they do, to make America a better place, with justice, liberty, honesty, integrity, accountability and the ability to collect and continue adding to the graft, which is issued from lobby groups that seek the same.

  13. Anonymous

    "From the beginning," Lockhart said, "OFHEO has been no match for the responsibility assigned to it of being the safety and soundness regulator of Fannie Mae and Freddie Mac. Together they represent more than a 40 percent share of the residential mortgage market, a share that has doubled since 1990. This unconstrained growth led to significant operational problems, mismanagement, and earnings manipulation"

    Lockhart blamed the credit markets for not providing normal market discipline to restrain growth. During the last 15 years the nations GDP doubled but the mortgage market tripled. The GSEs' guarantees quadrupled and their portfolios grew 900 percent. Lockhart said that much of this growth was based on the corporations' GSE status rather than their balance sheets

    Lockhart concluded by claiming that, were Freddie and Fannie not GSEs, the market would have made them quickly shrink their portfolio businesses. "The markets are not performing that discipline and OFHEO does not have the powers or tools to be a strong regulator, let alone be a substitute for market discipline."

    Above is from 2006

    Then>>>>>>Feb 28, 2008:

    The Office of Federal Housing Enterprise Oversight, which oversees the two government-chartered mortgage giants, said Wednesday that it was making the change because the companies have begun filing timely financial reports again, after accounting lapses several years ago. But the regulator declined to ease its requirement that Fannie and Freddie hold 30 percent more capital than they are required to by law, citing the turmoil in the mortgage market.

    The announcement came as Fannie Mae, the larger of the two companies, reported a $2.05 billion loss for 2007 and warned that home prices would sink further this year. The loss followed a $4.06 billion profit in 2006 and reflected a rise in mortgage defaults and soured investments.

  14. Anonymous

    10:38, the homes in blighted areas have ALWAYS been there and are not the ones that are backing GSE debt. Of course homes eventually grow old and have to be replaced just like any other capital asset. You seem not to grasp how big the GSEs are, nor the magnitude of what would have to happen for GSE backed debt to be of zero value. THE ENTIRE HOUSING STOCK OF THE COUNTRY WOULD HAVE TO BE VACANT WITH NO ONE WANTING TO MOVE IN. It’s just dumb. Too dumb to keep arguing over, so I won’t.

  15. Chris

    According to this ({6BCEEE01-6372-4A23-B761-E226DAF67C09}over at Marketwatch, Fanny and Freddy, between them, have more $200 billion of debt coming due before September 30th. Someone could break a lot more than a toe trying to kick that can down the road. Anyone know about the numbers and the dates? Does that happen every month? What might make this month different than all other months?

  16. Anonymous

    Anonymous 10:14 AM
    I profer that DD was not claiming all of the GSE debt is worthless. But the GSE debt that is targeted to be monetized by the FED, will, by design, be worthless.

  17. fred

    chris, the numbers sound big and scary but they are not large relative to the size of FRE and FNM ops. A molehill is being made into a mountain here, these number. Also, the GSEs have assets maturing at the same time. It is a mistake to just focus on one side of the balance sheet. Finally if they were unable to roll debt (seems hard to believe that you could not sell debt that is now explicitly backed by US govt but pays 100 bps over treasuries, but let’s say that happens) what will they do? Buy fewer mortgages.

    The hysterical commentary in the news the last few days is very ill informed.

  18. S

    Agree with Fred. The debate on the GSE misses the point completely. We know they have monster embedded losses. Any measure vs. “real” capital suggest insolvency. That said it is the abilioty to continue to grow and the funding cost that matter the most. The real questionis the GSEs continuing to buy mrotgages to sustain a market doesn;t really solve anything. The hope would be that ionflation helps erode some tf the debt, but that only works if inflatioon gets embedded in returns and wages. Not happening. So the only thing we are talking about is the timing of the crackup. All other debate is peripheral.

  19. Anonymous

    The balance in the portfolio and the structuring of liabilities is the point, i.e, Fannie mismanages everything they touch, with the exception of option grants and bonuses, but then again that has been a problem for decades, so by all means focus on Fannies assests.

  20. Anonymous

    Hello Unsympathetic…you are half right. It looks like the EQUITY of Fannie and Freddie will be wiped out. But the debt is likely to be fine. To become solvent the two will require about 100B of new Equity. That is probably what the bailout will amount to. Of course the far better solution would be to put the organizations into receivership, wipe out the managers (enriched at public expense) and equity holders, and then let the debt run out to pay bondholders. This will save the government from having to make good on the bond debt. It would also rid the landscape of these two awful anti-capitalist, public funded, leveraged, dangerous hedge funds that ply Congress with largess so they can continue enriching themselves.

  21. steelhead

    A question: If, to resell existing debt and to sell new debt necessary to recapitalize the GSEs, they are forced to offer coupon rates that exceed the rate of return on their existing portfolios (not the mortgage rate, but the actual rate of return), aren’t the GSEs the functional equivalent of zombies – dead already or soon to be? Also, doesn’t allowing them to continue to do business while this is the case only enlarge the eventual cost of the inevitable federal takeover?

  22. fred

    Steel, you seem to be under a mistaken impression. The GSEs are still making a nice margin on mortgages they buy, even if the debt is priced as it was yesterday. Mortgage rates will probably increase if the GSE’s experience higher funding costs. If somehow they got in a position where they could not profitably acquire new mortgages, they still would be sitting with a huge pile of assets that were generating lots of income. THey could let the liabilities run off until they could get back to borrowing at a workable cost.

    Anon of 3:36, you are on drugs if you think the GSEs need 100 billion.

  23. Anonymous

    The reason Freddie and Fannie’s takeovers are delayed is similar to why many bank takeovers are being delayed: there isn’t enough skilled manpower, nor enough preplanning.

    The Bush administration didn’t start thinking about what might be necessary 1-2 years ago. This despite major accounting and management problems at both firms.

    To a lesser extent, there was/is probably the hope that the problem can be dumped onto the next administration. The Bush administration has never made recruiting skilled people a priority. Especially imagine trying to recruit skilled appointees without civil service protection with 5 months left before Obama takes over and the composition of the house and senate have changed radically.

  24. Anonymous

    Fred said: “seems hard to believe that you could not sell debt that is now explicitly backed by US govt but pays 100 bps over treasuries,…”

    Maybe there is a difference of selling debt secured by morgage cashflows and selling unsecured debt?

  25. Anonymous

    Re: GSEs are still making a nice margin on mortgages they buy, even if the debt is priced as it was yesterday..

    >> That seems to be the consensus amongst shareholders who are now valuing future cash flows {(snark) ROTFLMAO).

  26. Fred

    6:08, the reason the “takeover” is being delayed is that there are no grounds for a takeover. No matter what Sean Egan and the NY Times say, the US govt can’t just decide on a whim to confiscate the capital that belongs to GSE shareholders. For the moment, the GSE’s are well-capitalized by statutory standards, the only standards that matter when it comes to a question of “takeover”. Hard as it may be to believe, there are quite a few well-informed parties who think that the GSE’s are highly unlikely to breach statutory minimums, though Yves and his greek chorus of commenters would have you believe such a breach is not only certain, but imminent. If you actually make estimates of reasonable loss scenarios and the effect they have on capital as they play out, you will see that it takes truly draconian assumptions for these companies to breach their minimum capital requirements. If interested, look at info posted at to see how one very well respected value investor analyzes the GSE situation.

    As a relatively recent visitor to this site, it seems to me that the general pattern is Yves finds a financial stock whose price has gone way down and then writes all kinds of stuff about how dumb management is and how obvious the problems were all along and how clear it is that the company is even more screwed than dummies like the treasury secretary grasp. He quotes all kinds of people who agree with him, and none who don’t. Then the Greek chorus kicks in with yes, thanks Yves for telling it like it is, I’ve been saying this for years, this company is already bankrupt. It’s like a giant echo chamber where you hear the same opinion over and over and become increasingly certain it is correct.

  27. mmm


    You admit you haven’t read this blog for long, and are hugely biased. Yves does not go dumping on every financial stock in distress. The only ones he has gone after in a serious way, as far as I can recall, are Ambac, MBIA, and Lehman (oh, and he hates Countrwide, but that seems to have more to do with their ethics). I don’t recall him going after IndyMac, WaMu or Wachovia, for instance, which seem to me plenty deserving targets.

    In general, he’s been saying that the housing market has further down to go and banks haven’t taken enough losses. He has been right on all those calls, but you try to claim that he’s an simply hates all financial stocks and imply he is not factual. Rubbish.

    If you are going to criticize someone, get your information right. You are the one making prejudiced, non-factual broadsides here.

    As for the GSEs, I’ve never seen Yves saying anything even remotely like “these stocks are going to zero.” In fact, I don’t recall him every making a call on a stock. And you are also mischaracerizing what he has said about the GSEs. He has called for the shareholders to be wiped out IF they get Federal support.

    You seem to be conflating what his readers say with what he says. It is also far from a Greek chorus here. People do jump on him, and each other.

    You also seem defensive and dogmatic. I wonder if you are long GSE paper or in their employ directly or indirectly. Given that you point to (and get high and mighty about) Pzena, which wrote a letter to Barron’s (on the website) which disputes the widely reported “is Fannie the Next Government Bailout” article, and also says Pzena is one of Fannie’s biggest shareholders, I’d guess you are with Pzena or an investor in them and are here talking your book.

    If true, that’s dishohest as hell.

    Regardless. you try to wrap yourself in the mantle of honesty and slur this site and the people who comment here, yet you make only general, unsupported charges, and provide only one source with a counterview and can’t even be bothered to recount what its case is or make any arguments on your own.

    Ad hominem, sloppy, and intellectually lazy.

  28. Anonymous

    Actually, I’m glad Fred wrote. I’ve noticed an increase of shill-type comments on the recent GSE posts. Maybe the longs are so desperate that they are even going to blogs to try to spin doctor!

    The MSM has a huge pro-company bias. When they start dumping on a big name, the gig is up. Yes, they overdo the volume on the upside and the downside, but they are lagging indicators as far as deterioration is concerned.

    I looked at the Pzena site too. They are keen about financials. They must be sucking wind right now. And we are supposed to take guys seriously who have been completely wrong? Now if Marc Faber or John Paulson said the GSEs were maligned, or Meredith Whitney said banks had bottomed, that would be a different matter.

  29. Anonymous


    That was a too close to a flame for my taste, but I agree with the substance.

    Fred, you are just plain wrong about rolling debt. If they cannot roll debt, that means they will default on the debt that is maturing. Not buying mortgages is no cure for an immediate cash shortfall. That would be a systemic event, trust me.

    And you do seem to be confusing this blog with other blogs. Mish is much more consistently and aggressively after financials. He’s had just about everyone in his shorthairs.

  30. Richard Smith


    You have neglected ten minutes worth of easy homework and it makes you look foolish.

    Yves was sniffing suspiciously at Ambac and MBIA as early as August 07, at which time their stock prices were in the 70s IIRC; no longer, eh?

    Around the same time this blog also pointed out the likely consequences for the IBs of their late dash into subprime mortgages. Care to review the IB stock price performance *since* then?

    Capital issues at Fannie Mae got a mention in November 2007…and here we are now.

    The Naked Capitalism baseball bat was deployed in its full splendour for Lehman’s last quarterly earning report, where a favourable number had been heavily and credibly leaked via all sorts of channels. The actual number turned out a bit different and the CFO took the fall. Justifies a certain level of doubt about Lehman management competence and integrity, doesn’t it?

    All these historical facts are readily verifiable. Try Googling the blog, mate, it really isn’t terribly difficult.

    Easy to see why mmm would get a bit tetchy about your post, to say nothing of the other regulars who got insulted en passant.

    By all means try and remake your point if it turns out the GSEs *don’t* need a big chunk of extra funding ($100Bn?) to keep going.

  31. fred

    You guys all just proved exactly my point.

    BTW, no, I do not work for or invest in Pzena. Just thought I would direct you to another viewpoint, but as expected, you don’t want to hear it.

    Enjoy talking to one another, I’m sure you are all correct in your consensus opinions and adoration of Yves – who, btw, did not bother to answer any of the questions posed to him in this set of comments.

  32. fred

    “I looked at the Pzena site too. They are keen about financials. They must be sucking wind right now. And we are supposed to take guys seriously who have been completely wrong? Now if Marc Faber or John Paulson said the GSEs were maligned, or Meredith Whitney said banks had bottomed, that would be a different matter.”

    This is hilarious. You probably don’t even understand why it is hilarious, but it is. Hint: compare Meredity Whitney’s long-term track record to Pzena’s.

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