The deed is done. Freddie and Fannie are now officially in conservatorship.
Uncharacteristically, I listened to the presentation by Paulson and Jim Lockhart, which was thin on details (particularly size of new facilities and investments). The bombshell was the aside that not only is there to be a new secured lending facility for the GSE as part of the rescue, but also for the Federal Home Loan Banks, which collectively had as of year end 2006, roughly $1 trillion of assets, In interest of getting this post out, I have not yet located the 2007 level, but trust me, since there was a backdoor bailout of Countrywide via the FHLB system (my recollection is roughly $50 billion of assets were offloaded), the total is no doubt bigger now. This was a mere aside, BTW, and I have not seen this detail picked up anywhere in the initial press reports, but is clearly contained in Paulson’s speech.
A second noteworthy feature was that Paulson took care to steer clear of saying the US was assuming responsible for GSE debt. The construct was “we created this mess by setting up a conflict between private ownership and public mission, a lot of investors and foreign central banks own this paper, we are responsible to straighten it out.” In the end, this winds up being a de facto full faith and credit obligation of the US (there is no way the US can walk from supporting the GSEs having started down this path) but in form, care was paid to set in motion a program that if successful would put the GSEs on a footing to function without life support. Indeed, Paulson said that “Treasury will assure positive net worth” and even though Treasury’s authority to act extends only to the end of 2009, there is just about no scenario (absent a Federal debt crisis) that the US can cut back that commitment unless and until the GSEs are radically reformed.
Third was that the program envisions the GSEs expanding their book of business moderately in 2009 to support the mortgage market, then shrinking their portfolios 10% a year starting in 2010 until they reach a size (not specified) where they no longer are so large as to pose a risk to the financial system.
Fourth, not surprisingly, the powers that be indicated that they had studied which banks who held common and preferred would be affected by the measures and ascertained that it was only a small number of smaller banks. They were encouraged to call their regulator to develop a capital restoration plan.
Fifth, Treasury will purchase MBS in an effort to lower spreads. Query how investors will take to the prospect of a less than economically-determined prices. Paulson argued this program may produce gains for the taxpayer (with the spread over funding, that’s quite possible)
Sixth, Paulson stressed that Congress needed to resolve the ambiguities in the GSE’s charter and it would be a mistake for a new Congress and Administration to neglect this task.
Other key points:
Both Paulson and Lockhart stressed that they had “determined it was necessary to take action” and it was “not in the best interest simply to make an equity investment in the GSE’s current form,” Lockhart indicated that the issue was capital adequacy, that Freddie and Fannie “cannot continue to operate safely and soundly and fulfill their mission.”
As expected,. all common and preferred dividends have been eliminated (note the word was “eliminated” not the more user-friendly “suspended of earlier reports). The government will invest via up to $100 billion of new senior preferred (the figure was not included in the presentations).
All lobbying has been eliminated.
The current CEOs will remain during a transition period. Herb Allison (formerly with Merrill, then TIA-CREFF) is the new CEO of Fannie, David Moffett, former vice chairman of US Bancorp, of Freddie.
After 2009, GSEs will pay a fee to government for support.
Further commentary comes from Bloomberg:
Morgan Stanley, hired by the Treasury to probe the companies’ finances, concluded the accounting, while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves, according to the people who declined to be identified because the findings were confidential.
From the Wall Street Journal:
The Treasury said its senior preferred stock purchase agreement includes an upfront $1 billion issuance of senior preferred stock with a 10% coupon from each GSE, quarterly dividend payments, warrants representing an ownership stake of 79.9% in each firm going forward, and a quarterly fee starting in 2010.