So Where is That GSE Bailout?

Yes, it’s the end of the summer, but the Fed boys worked over the weekend, so what’s the excuse of Hank Paulson & Co.? The saber rattling for the Fannie and Freddie rescue program to be unveiled is getting louder and louder.

We had an unmistakable demand from the Chinese over the weekend, if you somehow managed to miss it: From Bloomberg:

A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China’s central bank.

“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to questions yesterday. “If it is not the end of the world, it is the end of the current international financial system.”

You can’t say we weren’t warned.

Politer reminders came from some US financial heavyweights today, as Reuters tells us:

Two of the biggest U.S. bond investors said they would get involved in a capital raising by Fannie Mae and Freddie Mac as long as the U.S. Treasury participates in the new deals.

But Bill Gross, chief investment officer at Pacific Investment Management Co., and Dan Fuss, vice chairman of Boston-based Loomis Sayles, disagree on what shape any deal with Treasury should take, according to separate interviews on Friday.

Gross would be drawn to a straight preferred stock offering similar to securities sold by Fannie Mae and Freddie Mac in raising capital this year and last, while Fuss wants an offering of convertible debentures.

The real point of these statements was to remind the Fed that folks like Pimco and Loomis Sayles were going to sit on their hands until the Treasury unveils its program. Well, perhaps not entirely. Freddie’s note sales today were reported to have gone well, but at higher spreads than last week, so one has to quibble with that characterization a bit.

And John Jensen tells us that the mood in the markets is lousy:

Prices of Treasury coupon securities surged today as the credit crunch hovers and associated economic weakness hangs over the market like a funeral pall draped over a casket. It is sad and depressing and good news is hard to find.The day opened with the news that there would not be a Korean based deus ex machina for Lehman Brothers. The strange euphoria which this shabby story generated faded quickly.

During the day the depth of the problem resonated with word that JPMorgan in an SEC filing has acknowledged that it had lost $1.2 billion in write downs on FNMA and Freddie Mac preferred stock. If they are down that much what is the fate of regional banks with less capital and a far larger (percentage) holding than JPM.

It’s now no mystery that crafting a deal won’t be trivial (gee, you think they might have looked into what their little plan might entail before getting themselves and Congress committed to it. But then again, this is the Administration that occupied a Middle Eastern nation with pretty much no post war plans, apparently not even any civil affairs units).

Leaving the GSEs to their own devices is no longer an option; no one is going to pony up new equity, given the high odds that any investment by the government will wipe out or at least damage current shareholders. The Treasury would love to take out both the preferred and common equity holders, but too many banks, like JP Morgan, own preferred, and the last thing it wants to do is further weaken bank balance sheets. We’ve noted that the easiest-to-implement option would be for Treasury to bid for GSE debt when and if needed, but that’s a solution that the markets are likely to deem a mere stop-gap.

There is even lack of agreement as to what the government’s posture should be. The Administration could make a significant commitment to help the GSEs support the housing market. But with further losses in the offing, that step looks risky (funny how shifting a commitment from a contingent liability to on balance sheet changes one’s perspective). And with fall campaigns about to gear up, there seems to be some reluctance to take big moves (odd, that doesn’t seem to inhibit the Adminstration from a keeping up war of words with Iran, or unilaterally abrogating the ABM treaty).

In case you doubt a rescue is necessary, consider the words of Financial Times columnist John Dizard:

Fannie Mae and Freddie Mac need to be nationalised, in the sense that the federal government injects capital in the form of preferred equity and direct credit support, wiping out the existing common. I believe it is critical that that takeover leaves the privately held preferred stock of the government-sponsored enterprises in place. Preserving the value of GSE preferred issues is very much in the taxpayers’ interest, as it makes possible the recapitalisation of the rest of the banking system.

Most of the discussion of the need for a federal takeover of the GSEs has concerned their credit losses on subprime and Alt-A paper. However, even if a private recapitalisation could be done to offset those, the GSEs would not have sufficient capital to handle the long-term risk of the maturity mismatches on their highly leveraged balance sheet.

Let’s say there’s a great economic recovery, housing prices stabilise, and the interest rate curve becomes more normal. The rise in long-term rates would lead to an extension of the maturity of mortgage portfolios, which would need to be offset by hedging activities. Significant declines in the long end would also need to be hedged, as homeowners refinanced. I don’t believe the interest rate swaps market will have the capacity or willingness to take on that risk at any payable price. One way or another, these institutions will spend a considerable time with negative equity. Again. The only way to handle that is with government ownership.

No doubt there are bankers and lawyers explaining all this to the Washington “leadership”, in the respectful, but urgent, tones trust and estate lawyers use when telling dim heirs that they need to sign a document lest Mummy’s bequest become valueless. It could take a little while for the political managers to accept that they need to shred yet another set of talking points.

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  1. jest

    Dumb question:

    Are all these machinations mostly regarding the MBS, or the corporate debt? Do the foreign central banks prefer to own the mortgage backs or debt?

    I always thought the implicit guarantee was behind the MBS, not the corporate paper. (if I'm wrong, please correct me)

    If that's the case wouldn't the sensible thing to do be letting them go bankrupt (i.e., liquidation) & the gov't insure the MBS, rather than insuring the MBS *and* the corporate paper? especially since their derivative books are a proverbial black hole.

  2. Lune

    I’m still very much of the opinion that the GSEs should be allowed to fail. Call me a curmudgeon who won’t listen to “reason”, but the govt has always *explicitly* said the GSEs don’t have a government guarantee. That’s why there’s always been a spread between treasuries and GSEs. If you didn’t believe what the government was explicitly telling anyone who would listen, then why does the taxpayer need to rescue you from your own stupidity? And anyone who states that guaranteeing the GSEs is very much in the taxpayer’s interest needs to explain how letting them fail will cost *more* than the $1 trillion or so it will cost us to nationalize the GSEs.

    Secondly, I find it incredulous that Dizard would advocate wiping out common stock but not the preferred. In other words, if there’s a bailout, restrict it to the banks, and not the common Joe who might have stock investments. And this is in the public’s interest? Please. The public’s interest will be served when the current banks that got us in this mess go bankrupt so that new ones can be allowed to form. If equity is wiped out, it should *all* be wiped out. Not just the retail investors.

    Finally, if the GSEs are nationalized, I’d like everyone who currently holds GSE debt to refund to the treasury the spread they earned between treasuries and their GSE debt. After all, if they fully expected a treasury guarantee, they should have only been earning treasury rates. (I know. Talk about wishful thinking…)

    Oh. And one last thing: if the GSEs are nationalized, why not cut out the entire mortgage industry edifice, and just provide mortgage loans directly from the treasury at treasury rates? Since the nationalization of the GSEs means that the vast majority of American homeowners are actually borrowing directly from the govt and that their loans are secured by a govt guarantee, why should the American homeowner be charged 6% interest when comparable govt securities are bought for 4%? Why allow bank intermediaries to profit from that spread?

  3. Anonymous

    “The Treasury would love to take out both the preferred and common equity holders, but too many banks, like JP Morgan, own preferred, and the last thing it wants to do is further weaken bank balance sheets.”

    Well stated and insightful! Too bad about the shadow of these wounded GSE dinosaurs looming over the market — we can’t make JPM lose money on a boneheaded investment, the way little people do.

    I mean, Fannie and Freddie weren’t even reporting results for an extended period. What kind of due diligence was JPM doing, when it accumulated all that preferred? Was it a nod and a wink from Hank, as in “These are SPONSORED enterprises, boyz [wink, wink]. Load up the truck!”

    Dizard is right that the GSEs are undercapitalized, and that if anything they need MORE capital than similar-sized banks, owing to the fiendish difficulty of hedging mortgages with their variable, unpredictable duration. All parties involved are still lying that they ARE adequately capitalized, as the banksters demand protection from their cronies in Treasury (“Don’t zero out the Fannie preferred, or we’ll shoot this dog!”)

    The GSEs were a “government-business partnership” from the beginning, and corrupt crony management has created a predictable debacle. The “deliberate ambiguity” model has failed. Getting Congress, which couldn’t manage a lemonade stand, out of the picture is vital, whether the ultimate solution is private or public.

  4. Scott Frew


    With regard to your comments, my sources tell me that official foreign buyers—central banks, Treasuries/Finance Ministries etc—received explicit guarantees. I’m not positive whether they (my sources) surmise that, or have direct confirmation, but they’re definitely in a position to know. Foreign official holdings of GSE debt sum to just under $1 trillion. The big holders—Russia, China, Japan et al, are also huge holders of US Treasury debt. One aspect of the Fed not being in charge here revolves around the fact that those foreign governments, as such huge holders of our debt, have a loud voice at the table when our policy decisions are made, and the GSE debt is one place where that voice has definitely been raised.

    With regard to the preferred, mid-sized banks own so much of it, particularly as a percentage of their total capital, that giving that a huge haircut becomes a cutting off your nose to spite your face gesture. In moments of weakness, or perhaps it’s strength, I think just letting the chips fall is the right way to go about this, but I think ultimately those are Mellon moments—
    liquidate labor, liquidate the farms, etc—that I’m not sure I want to participate in.

    We’re going to have on the order of 1000 bank failures by the time this is over anyway; wiping out all the holders of GSE preferred is unnecessary gilding of the lily, as tempting as it is from a just desserts angle.

  5. RK

    Scott Frew is absolutely correct that not backing the GSE’s debt would be disastrous. An important but
    not much discussed problem is how treasury is to
    support the GSEs without triggering an event of default under the CDS’s written on both entities. Such an event could have a cascading effect like the one the Bear Stearns bailout was alleged to have stemmed. One would need to know the exact language of these CDS to be able to judge what events could trigger default, which is difficult because these documents are not public.

  6. Scott Frew

    RK, as soon as I hit the send button on my previous comment, I realized I'd forgotten to mention the cds issue. $62 trillion written on fannie and freddie debt, fair value $2 trillion–that's about 15% of gdp. Unfortunately, there's a damned if you do-damned if you don't aspect to it. Here's Gretchen Morgenson, writing in the NY Times on Saturday:

    “If we reasonably assume that the Treasury would only intervene in the event that Fannie or Freddie is declared significantly undercapitalized by its regulator,” UBS analysts wrote, “then interest payments on the qualifying subordinated debt is automatically deferred for up to five years.”

    Because nonpayment of interest would be seen as a credit event, UBS added, entities that have bought protection on Fannie’s and Freddie’s subordinated debt would be entitled to payment by the entities that wrote the insurance. This, even though taxpayers are standing behind Fannie’s and Freddie’s debt, not allowing it to fail. Talk about the laws of unintended consequences.

    Yves, perhaps this is one factor in Paulson's Hamlet-like posturings?

    The full article's here.

  7. Anonymous

    The ‘ownership society’: an idealogical construct devised by pig men to allow ownership of homes by all with a pulse, while generating great profits and bonuses for the pig men. The ‘ownership society’ idealogy is meeting the reality of the market. The market is not an idealogical construct but a collection of (more or less) realists with capital to lend to those deemed reasonable credit risks.

    Idealogy will prove itself a mismatch for the reality of the markets in the long run, no matter how government agencies intervene and warp markets in the short run.

    ‘A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China’s central bank.’…This is a correct assessment of the situation, imo.

    In addition, a bailout of the GSEs could kick the can down the road into the lap of the next administration. Seen in this light is there really a lot of doubt about what decision will be made regarding a bailout of the GSEs?


  8. Anonymous

    Just because you can quote some random columnist saying a rescue is obviously necessary, that doesn’t make it so. Perhaps you should try quoting someone who actually does analysis.

  9. Anonymous

    Here are excerpts from an 8/22 report from an analyst at Citi:

    We are not convinced that Treasury needs to
    take any action over the near-term… Funding Access Remains Good… Treasury does not have the authority to
    step in and seize the GSEs, as long as their capital meets the required
    minimum capital adequacy standards (which they do).
    in the Housing and Economic Recovery
    Act of 2008, SEC. 1117(a) it states that: Nothing in this subsection
    requires the corporation to issue obligations or securities to the Secretary
    without mutual agreement between the Secretary and the corporation. Nothing
    in this subsection permits or authorizes the Secretary, without the agreement of
    the corporation, to engage in open market purchases of the common securities
    of the corporation.
    The GSEs could shrink their retained portfolios through natural runoff.
    FRE and FNM experience about $10-15 billion of pay-downs of
    retained portfolio assets each month. If this runoff is not replaced, we
    estimate that FRE and FNM would each free-up $3-4 billion of capital
    The GSEs could simply ride out the storm. This may be the most likely
    near-term option, given the fact that the GSEs continue to perform
    their mission of supporting affordable mortgages (albeit with some
    capital strain) and the Treasury plan is currently working. Our analysis
    suggests that both FRE and FNM have sufficient capital to continue to
    grow their guaranty portfolios and maintain their retained portfolio
    balances (replacing run-off with new purchases of agency securities)
    for at least the next two quarters. Our model assumes that FRE is able
    to raise the $5.5 billion in capital that it plans to raise and that growth
    in the guaranty businesses of both GSEs will modestly exceed the
    growth rate in mortgage debt outstanding. Nevertheless, if FRE’s
    planned capital raise is not executed, we believe it could have less
    cushion above the statutory minimum capital requirement in 4Q08;
    however, we still expect FRE to remain adequately capitalized as
    defined by their statutory capital requirements .

  10. Anonymous

    Fox Pitt analyst on 8/8 said:

    By our analysis, FNM would need to incur more than $54 b in losses
    over the next 6 quarters (see Exhibit 1) for its minimum capital
    levels to be endangered. We regard such a scenario as highly
    unlikely, as we will explain, and therefore a further substantial capital
    raise would be unlikely… We recognize that management has said that they cannot be certain of capital adequacy
    into 2009 and that is certainly true theoretically. Tail risk does exist and we cannot rule
    out a prolonged steep recession. Nevertheless, $54 b in losses seems unlikely to us in
    such a short time period. To the extent they would occur over a longer time period, the
    company would accrue further revenues to offset.

  11. Anonymous

    Given that these entities are currently private, the only way to legally disposses current owners SHOULD be through regular bankruptcy proceedings and debt discharge.
    Any other method would be (politically speaking) socialist, and (legally speaking) government theft.
    While no one knows how the courts would react if lobbied hard enough behind the scenes (because it is an extraordinary event), they SHOULD not countenance any theft of the real owners’ property (the common share owners).
    If that messes up the system, even in a catastrophic way, so be it, but for this country to violate the basic precepts of protecting private property, would be even more catastrophic.
    We have already had the gold cases, and lately Kelo vs. New London, this would be just another step toward socialism, destroying the constitution even more, and all in the name of the greater good (which of course is a lie anyway). If the system were to collapse, that would be the chemo-therapy needed to cure its ills.

  12. Anonymous

    From a Lehman report 7/22:

    Given the strong credit quality relative to the industry, we believe their capital cushions above the minimum are big enough to offset
    expected losses, particularly with such strong revenue growth… even if
    losses come in higher than we’ve estimated, the GSEs should have several billion dollars of additional capital to absorb these losses. While
    Figure 3 assumes FRE raises an additional $5.5B as it has committed to do, which would be dilutive at today’s valuations, we estimate FRE
    could remain adequately capitalized even without the capital, particularly if it slows growth…. the liquidity backstop and the potential equity investment will only be exercised if needed, which
    we don’t anticipate given the companies’ continued access to the funding markets at relatively tight spreads and their substantial current
    excess capital positions. Given the GSEs are above their capital requirements and we expect them to stay that way, equity capital from the
    Treasury will likely not be needed… It’s important to note that, as both OFHEO and FRE pointed out in
    recent releases, FRE does not have an immediate need to raise capital, so they are not compelled to issue capital when market conditions
    are unfavorable… OFHEO Director Lockhart already articulated, the capital requirements should not change because the current requirements already
    contemplate the real economic risk of the GSEs… it’s the GSEs’ core capital levels,
    not the stock price, that dictate whether the companies need capital. As of June 30, we estimate that FNM exceeded its surplus capital
    requirement by roughly $13B, and FRE exceeded its surplus capital requirement by about $7B. Thus, given our current estimates through
    2010, we do not see a need for the government to actually buy any stock (prfd or common) during this cycle.

  13. Scott Frew

    Okay, I promise to shut up after this comment. Anonymous of 9:26, if your comment was directed at me, you’re right, at least to the extent that Morgenson is clearly wrong in her numbers; the $62 trillion is total cds extant, not cds written on GSE debt. I think the UBS analyst’s point stands, that a “rescue” which entails a halting of payments on the preferred is a credit event, and will trigger cds payments.

  14. Anonymous

    Scott, my comment was directed at Yves, who quotes a clueless columnist named Dizard as proof that a rescue is necessary

    Morgenson is a clown, too.

  15. AndrewBW

    With Bush approaching the end of his presidency and a new president coming in in January, what is the likelihood that — barring a catastrophe requiring an immediate response — there will be any significant action on the Fannie/Freddie front until at least November, and maybe January?

  16. Anonymous

    I have posted this before and it is still valid:
    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. This doesn’t even take into consideration the FanFred securities held by brokers and Investment Banks. Add to that foreign central banks and sovereign funds and you have a situation that makes Bear Sterns look like a walk in the park.
    The solution to the entire economic slump is to have the government to lend directly to the public. 50 year mortgages at 4% would turn the economy on a dime and would not cost the taxpayers one. This problem began with mortgages and it will end with mortgages.

  17. RK

    Just a minor point on adequacy of GSE regulatory capital. $36 Billion combined between the 2 agencies is in Deferred tax assets (what you and I would call
    a loss carry forward against possible future income)
    This “asset” only has value against possible future profits, and is non transferrable. It is the dike protecting them from insolvency.

  18. Anonymous

    RK, the companies are generating a combined $20 billion a year in revenue. There is no reason to think that they will never again earn profits against which they can use the tax credit. Pricing is up, market share is up, losses are not infinite. If you were liquidating the company today, you’d ignore that asset, but it is silly to pretend it has no value when the companies are still in business. Ironically, if the government were to sieze ownership of the companies via a capital injection, the asset would become worthless to the government.

    In any event, like it or not, that asset is included in statutory capital, which is all that matters.

  19. Anonymous

    Anon from 10:40 says:
    “The solution to the entire economic slump is to have the government to lend directly to the public. 50 year mortgages at 4% would turn the economy on a dime and would not cost the taxpayers one. “

    NOT! This would only be the solution IF people must have mortgages that they otherwise could not afford.
    BUT, there is NO right to own a home. If you can’t afford one, then so be it.

    Having said that, we would not be in this mess, if housing prices had not been allowed to hyper-inflate these last 20+ years, going from 2.5x annual earnings to as much as 11x annual earnings.

    So, our government meddling (ith our money and the housing market specifically) caused the problem in the first place, then they make it worse (and prolong it) by takeovers and bailouts.

    At the heart of this is the abrogation of money control by congress to the Federal Reserve. The only way that cabal can ever be broken is with a systemic collapse. It won’t be easy, and won’t be nice, but would be good. I reiterate my chemotherapy comment here: The Federal Reserve is the cancer, and the collapse is the chemo. The longer one waits when treating cancer, the worse the chemo becomes, and at some point the disease becomes terminal. Let’s hope we are not there yet, but we will get there if this bailing out/meddling continues.

  20. pepster


    Assuming that your sources are correct and that foreign CBs have indeed received explicit guarantees from Paulson and co., I think they would be absolutely foolish to believe in it because, as AndrewBW pointed out, there will be a new administration in January. There’s nothing to stop Obama or McCain from going back on promises Paulson and co. have made.

  21. gaius marius

    If these bozos are bailed out, I am not paying taxes for the rest of my life.

    if these bozos are bailed out, few of us will do anything but. the american government is not an infinite debt sink. there will be a bill that comes due.

  22. Scott Frew


    I don’t necessarily disagree with what you say, in principle at any rate. In practice, though, we need to issue new debt simply to cover the interest payments on our current debt. Given those circumstances, to figuratively tear up promises made, even sotto voce, by a previous administration would be suicidal. We’re in no position to dictate terms here.

  23. Michael

    I have been reading many, many articles/comments on the GSE bailouts. Everyone has a different bit of data that points to horrific consequences if it happens or unintended consequences galore.

    I see two major forces pushing this to happen.
    1)Foreign governments wanting their investment protected no matter what.
    2) Investment banks,the bond market, and individual investors.(wall street)

    Everyone wants protected and if they win then some other group faces major problems.

    What would be great is if someone smarter then me would break down the big players in this and what happens to the other players if they get the support.

    My opinion is the foreign investment gets first consideration because we need them to continue buying our debt for us to function.

    The ultimate loser is the taxpayer, by far the largest constituent with the smallest voice.

    Every generation is judged by the world they leave their children.

  24. Anonymous

    We would not be in this mess if the banks had not committed massive fraud and sold mortgages that homeowners could afford, only to see their monthly payments triple in a couple of years. During the depression mortgages were amortized over 5 years. That is when 30 year mortgages were born. This is not a government subsidy of mortgages, it simply makes housing affordable and thus keep the global economy from collapsing. When we LOANED Chrysler the money to stay in business taxpayers actually made money. The same goes for the Resolution Trust Corp. Calculate the cost of another great depression, and see what you can afford after it becomes reality.

  25. Anonymous

    anon from 3:21 says:

    “…if the banks had not committed massive fraud…”

    That fraud is only in the implementation of a larger fraud. True,these dubious loans allowed the pie to keep growing, getting bigger and faster so than without this. But where was the oversight all those years by the Fed, which then ALREADY HAD the power to prevent it, but did nothing. Why, because it was the sink–hole for their credit/money creation to grease this fake economic boom via inflation.
    The reason you used to be able to amortize in a few years was because for generations housing only cost about 2-3x annual earnings.
    That is AFFORDABLE.
    If Congress really wants affordable housing for all, then the market should be allowed to go back to 2-3x annual earnings.
    It would be nice if that ratio could be reached by housing prices staying where they are and wages/salaries increasing to match, but if you believe in that possibility, then I have a cheap home in Las Vegas or SoCal for you.
    But with median wages flat for years, the housing price will come down to the 2-3x level eventually, that of sustainablility.
    Without money/credit inflation, this would not have happened, so the blame ultimately rests on those that produced the larger fraud of fiat money, and they sit at the Fed in DC (and NYC).

  26. AndrewBW

    My question is not so much whether an Obama or McCain administration would renege on any promises made by the Bush administration as it is wondering whether the Bush administration would even put into place some plan of action that might subsequently be changed by a new administration (unless their actual goal was to actively impede the actions of Bush’s successor). An Obama or McCain administration could easily do that without going back on any promises made.

    In other words, are we destined to hobble along for another half year with no resolution of any sort?

  27. Anonymous

    to andrewBW:

    Doing nothing at all by the gov. would be a good idea for once.
    Without government interference, we will not hobble along.
    Mr Market will resolve in one way or another, and even if that causes pain, it will be the right resolution.
    Thus, it would be the best scenario if they did nothing.
    Possible? Hardly.

  28. Yves Smith

    All of the “the GSEs have enough capital” analyses miss several points.

    First, as we discussed in a prior post, they assume a standard of mere solvency. That is not an appropriate benchmark. As we wrote:

    In their role of providing/guaranteeing mortgages, they have to be able to fund at the very best rates. That means they need to be an AAA credit, or at worst, a very strong AA. Mere solvency is BBB, perhaps even BB or B. Simply being solvent doesn’t cut it…..Fundamentally, this isn’t about GSE solvency. Despite all the legalese otherwise, GSE paper’s rates ALWAYS presupposed a Federal guarantee. Those tight spreads made no sense based on their stand-alone financials.Now that guarantee is being tested, and the government has blinked. Any wonder the market is spooked and effectively forcing the Feds to recant?

    The GSEs cannot fulfill the mandate set forth in their charter if they take the some of the steps advocated by analysts, such as shrinking their balance sheets. And Congress clearly does want the GSEs to do more; indeed it was the announcement of various "rescue the housing market" ideas that led to the spike in Agency spreads in late February and helped precipitate the Bear crisis. So if this situation is not resolved, the disruption and uncertainty in the credit markets will continue. I wouldn't put it past our friendly foreign funding sources to sit out a couple of Treasury and Agency auctions to make explicit the cost of losing their support.

    As for the legal authority to intervene, I am no lawyer, but the GSEs operate under a charter and subject to regulation. Regulators have quite a few tools to force submission if someone tries calling their bluff. Paulson and OFHEO might not have the stomach for that, which is a completely different matter.

    Second, I would not be so quick to dismiss Dizard. He has extensive connections in the fixed income world (unlike Morgenson, who clearly is at sea there) and was writing about Fannie and Freddie long before anyone thought they were an issue. He is correct to point out the widely-ignored issue of the GSE's derivative books. They were so large in 2002-3 that Greenspan was concerned that they were creating systemic risk (their hedging is pro-cyclical) and the accounting scandals were a blessing in disguise, since they halted growth. You will note the the analyses cited above do not factor in the mismatch/derivatives risks, merely credit losses.

    Third, others have looked at the credit exposures and come to different conclusions. Josh Rosner, looking at peak losses in 2002-3, concludes the GSEs need at least $40 billion in additional equity, but thinks the more realistic number is $100 billion.

    Standard & Poor's has arrived at a far greater cost estimate than Rosner's. The rating agency estimated that in a worst-case scenario, the cost of a rescue ranged from $420 billion to $1.1 trillion of public funds. S&P noted that the cost of a GSE rescue might even put the US's AAA rating at risk.

  29. Yves Smith

    Separate issue: I’m surprised there isn’t more outrage at Scott’s G2 that the Administration (I’m assuming the current incumbents, but the Clinton crowd may also be guilty) made such a promise. This is a massive case of the Executive encroaching on the Congress’ turf (although this presumably is not yet widely known).

  30. doc holiday

    Re: S&P noted that the cost of a GSE rescue might even put the US's AAA rating at risk.

    >> Now that, is an interesting thought! As a somewhat rhetorical question: How then, would Moody's/S&P or some other rating agency give a fair analysis of the future value of America? They have no clue ow to rate anything, so why would any opinion of a second-rate, second-class fraud-filled rating agency have any weight in a world gone mad?

  31. Anonymous

    Those rating agencies’ fraud has consisted of being way too generous with issuers, as in keeping ratings too high for too long.

    Given that record, the warning of a possible US downgrade (and Moody’s said the same might happen in the next decade before the Freddie/Fannie mess was part of the equation) says they are more likely to be candy-coating than being too pesssimistic.

  32. Anonymous

    If there is bailout, why not have the government fund a new company that would take on a large portion of the assets and liabilities that are deemed to have minimal risk and leave the shareholders with the remaining. That way if the remaining assets perform, the GSE’s can continue but as private entities. The government then gets the fee for insuring the losses on the good portfolio.

  33. Genesis

    Scott, one thing….

    If you nationalize (guarantee) the entire book of business then you have doubled the public float on the federal debt.

    What does that do to T prices? If it doubles coupons what happens to prices…… (duration x rate move, remember?)

    The Chinese and Japanese can whine all they want and rattle their sabre, but they must know that in reality, you can’t bail out something without a “bigger something”, and unfortunately, there is no “bigger something” with which to bail!

    That’s a problem, and now that the market has called Paulson’s bluff, the truth is starting to poke through the curtain.

    Why hasn’t there been action yet? Because there won’t be until and unless debt auction(s) fail. There can’t be except in that circumstance, because the risk of blowing Treasury coupons when the governing is compelled to issue record new supply is something that has to have Paulson seeing vampires in he sleep. In truth, he may be forced NOT to draw his “Bazooka”, lest everyone find out that what he really has is an empty launcher.

    Paulson made a critical error claiming to have a “Bazooka”; now his PUT has been exercised, and he’s got a bit of a problem with his margin balance.

  34. John

    Re: The 50yr at 4% comment.

    This is a great idea. It’s now obvious that THE most powerful country in the entire whole-wide-world is a socialist/fascist oligarchy, so this would make it official (to the non-peasants, anyway) AND delays “the crisis”. The banksters would be happy, both nobility parties would happy, and the majority of the peasantry would be happy. What’s the problem? Everybody wins.

    Regarding those who expressed their “indignation” at this idea:

    You’d go along with the program like everybody else that’s “unhappy” with “their” representative government. The government sets the rules for the benefit of “everybody”. You don’t like the rules you’re just another unpatriotic liberal trrrrrrst. Besides, everybody on here is smart enough to win if the rules are known. Personally, I only need to get through another 30 years. (Btw, a little known fact is that when I die the universe ends, so plan accordingly.)

    The “50 yr at 4%” idea sounds like something the Democrats can run with; their dumb-ass believers will love the socialist aspects of the “50 at 4 loan program”. The Republicans can shake their ideological-hands and “show” their dumb-ass peasant followers that they disagree and “STILL believe in the greatness of `merica, free enterprise, and the honest hardworking bid`ness man”. Both Parties get to continue ruling, the socialist/fascist system continues uninterrupted. Throw in a well timed minor skirmish here-n-there and the macho stature of our military might will be enhanced ensuring an endless supply of foreign credits.

    It’s brilliant!

  35. Francois

    anon @9:58 wrote:

    “We have already had the gold cases, and lately Kelo vs. New London, this would be just another step toward socialism, destroying the constitution even more, and all in the name of the greater good (which of course is a lie anyway). If the system were to collapse”

    This “another step toward socialism” reminds me a a colleague who had a 14 y/o patient with cancer. Needless to say the poor kid was in great pain. (bone cancer) Alas, his father was a principled, ideologically-driven bonehead. When he realized that his sons’ pain required the use of morphine, he went ballistic. “I won’t let my son become a god damned JUNKIE!!”!

    I can’t discuss the particulars of this affair, but suffice to say that it got unbelievably ugly, and that the burden fell on the victim to “endure” his pain.

    Now, substitute “patient” by “taxpayer” and “socialist” by “junkie”, and you’ll get an idea of how bad things could get.

    As much as I am loath to maintain Phony and Frauddy alive (for the moment) there IS a greater good problem here. (Hint: We, the USA, suffer from the cancer of too much debt.)

    We got to deal with it, whether we find it repugnant or not.

  36. Francois

    “My opinion is the foreign investment gets first consideration because we need them to continue buying our debt for us to function.

    The ultimate loser is the taxpayer, by far the largest constituent with the smallest voice.”

    Ya! Fact is the taxpayer was sold a free lunch…and he/she believed it.

  37. Anonymous

    SO a summary of Yves argument is:

    1) Some people think the GSE’s will lose lots and lots of money. Among these people are a columnist who has lots of connections, and a guy named Josh Rosner who thinks the GSEs need to raise $100 billion of equity but says in today’s WSJ that Treasury doesn’t need to do anything imminently unless the companies lose their ability to tab debt markets at reasonable cost. This last, apparently, we should not rule out because Yves “would not put it past” certain funding sources to sit out auctions.

    2) Even if they don’t lose lots and lots of money, they are inadequately capitalized – not according to statute or any financial calculation, but because they are not fulfilling their mandate of funding mortgages at “the very best rates”

    3)Therefore, treasury must intervene. Yves is no lawyer, but he thinks that even though the language of the law is clear, even though there is no precedent for confiscating capital in this manner in this country, even though the treasury secretary himself has said he has no plans to use the spending authority congress has given him, even though the regulator continues to say the companies are well capitalized, even though Barney Frank says the companies are well capitalized and should remain private, well Yves still thinks that anything can happen.


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