Freddie, Fannie and (Sort of) Federal Home Loan Bank Bailout

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.

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50 comments

  1. Matt Dubuque

    Paulson and Lockhart BOTH commended GSE management this morning. This is asinine!

    HERE IS THE FRAUD, which I, as someone who has passed the Bar, am convinced that any Attorney General of any state could easily obtain an indictment against any person connected with or who ratified the decision below.

    THERE IS NO RATIONAL REASON for the accounting change described below OTHER than to intentionally deceive the investing public. That’s a felony. Period. No exceptions.

    From Today’s NYT:

    http://www.nytimes.com/2008/09/07/business/07fannie.html?hp

    “Finally, regulators are concerned that the companies may have mischaracterized their financial health by relaxing their accounting policies on losses, according to people familiar with the review. For years, both companies have effectively recognized losses whenever payments on a loan are 90 days past due. But, in recent months, the companies said they would wait until payments were TWO YEARS late. As a result, tens of thousands of loans have not been marked down in value.

    Matt Dubuque

  2. Matt Dubuque

    Because all 50 states’ pension funds invested in these securities, ANY state Attorney General can seek criminal RICO prosecution under the following grounds:
    “Finally, regulators are concerned that the companies may have mischaracterized their financial health by relaxing their accounting policies on losses, according to people familiar with the review. For years, both companies have effectively recognized losses whenever payments on a loan are 90 days past due. But, in recent months, the companies said they would wait until payments were TWO YEARS late. As a result, tens of thousands of loans have not been marked down in value.

    It’s a slam dunk indictment. (and truth is an absolute defense to libel)

    Matt Dubuque

  3. ruetheday

    > 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.

    This is wishful thinking. Kinda like saying "we're going to give the heroin addict a little more heroin to help his withdrawal, but we recognize we need to wean him off eventually". What happens if the credit market still sucks in 2009/2010?

    > Fifth, Treasury will purchase MBS in an effort to lower spreads.

    I have a real problem with that. No different than if Treasury said "we're going to start buying fiber" in 2001 to help out the struggling telecoms. All of this is predicated on the belief that this is a short term issue and pretty soon housing prices will come back. How's that Tokyo real estate you bought in the late 1980's doing?

  4. etc

    Sounds like the CDSs referencing FNM or FRE debt didn’t make it a credit event to wipe out preferred shareholders.

    Since Pershing wrote and public letter into Treasury about wiping out the preferred, I’d guess them and other shorts will make money from wiping out the preferred, maybe from short positions on the preferred and/or stock of the regional banks that held FRE or FNM preferred.

  5. Anonymous

    Summary?

    They screwed the little banks

    They screwed the pension funds

    They helped the big banks

    The debt still has question marks around it

    Who will buy the new preferred but the gov’t?

  6. ndk

    THERE IS NO RATIONAL REASON for the accounting change described below OTHER than to intentionally deceive the investing public. That’s a felony. Period. No exceptions.

    If you consider the GSE’s guilty due to this activity, then you must also consider Wells Fargo and a host of others guilty. I’m actually stunned they hoisted this out and called it misbehavior. It’s widely known and I thought everyone considered it benign regulatory neglect. I’m guessing some politicians involved in this activity didn’t understand how the game has been played recently.

  7. esb

    Treasury yields will rise and spreads will come in … close to a wash, I will wager.

    The preferreds are now essentially common and so take the biggest hit in the deal.

    Seems like this was done to fully whack the most recent moral hazard bets of the last few weeks. Either that or perhaps some punishment was due to Gross for some peccadillo.

    Watch the price change in HABDX Monday to see how Gross comes out on this. Net net it rises slightly, I will wager.

    Unless the markets open higher and then all crash simultaneously in disgust.

    Incidentally, if we do now have a crash, I suspect that Paulson will be out immediately, in the same way he would be out were he running a hedge fund that he blew up.

    He seems to believe that he is running a private money shop.

  8. etc

    m: “how does this affect Bill Gross? Does he get screwed?”

    No, pimco is helped. They own FNM and FRE securities senior to the senior preferred the USG is buying. This means if FNM or FRE run into trouble, the USG takes losses first. Obviously though, pimco would prefer if the USG provided an outright guarantee, which puts the USG on the hook for unlimited risk, rather than merely the risk of losing its investment in senior preferred.

  9. VoiceFromTheWilderness

    A fee for support, oh, yeah, that makes sense, jolly good. So they are going to take money in from the government, hand some of it out to people who have enough assets left to buy the new stock, then pay back to the government a ‘fee’ for the glory of being able to participate in this sillyness.

    Oh goody a new way to funnel taxes to rich people, and here I thought tax cuts were a bad sign.

    Expect to see sudden ‘reality’ speaches from who ever is elected in the coming new year about how taxes have to be raised to cover the federal debt. Maybe we can have a ‘debate’ about who ‘ought’ to pay these new taxes.

  10. doc holiday

    I like the allusion to fiber here from the dotcom spiderweb, i.e, this is the same situation. What if JDSU had been bailed out by Treasury, in the form of Treasury accepting thousands of mile of fiber cable as collateral so that Treasury could offer JDSU bond holders a dividend for a few years, while the fiber gains in value — this of course in regard to supply and demand metrics and marking-to-market a sweeter deal down the fiber road, when time and future value coalesce into the perfect storm, where speculators make a killing!

    If Treasury had made that deal 6 yers ago, Treasury would still have a back lot filled with decayed fiber cable that would be worthless and written off, thus Treasury will end up forgiving this debt down the road, as they play third world banana republic. Meanwhile, as that occurs, the speculators that get bailed out, get a free ride from tax payers and no one goes to jail and then this cycle re-invents and renews itself into the next re-packaged, re-engineered mafia-backed fraud-induced scam, which retarded rubes will fall for, because, as we know, idiots are born every second and for every idiot there is a new mouse trap with his or her name engraved in plan English … and it says, I’m safe and all that shit you heard about risk is bullshit, trust me!

    Will we hear any snarky comments from the worst Senate and Congress in American history, or are they too busy counting lobby donations??

  11. mmckinl

    Calculated Risk ~

    “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)”

    What have you been smoking ? Banks have been delaying recognition of defaults for months and guess which MBS will be first to the block.

    This is an out and out public bailout that won’t be recognized until after the thieves have flown the coop.

  12. Anonymous

    mmckini

    I’m shocked, shocked that you would even suggest anything untoward with the Tsy purchaes of MBS on or behalf.

    Surely, Larry Fink at BlackRock and Bill Gross at PIMCO will be ‘retained’ by the Tsy to look out after taxpayer interests.

    We have nothing to worry about.

  13. Tom

    “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.”

    Actually the size is specified:

    Each GSE’s retained mortgage and mortgage backed securities portfolio shall not exceed $850
    billion as of December 31, 2009, and shall decline by 10% per year until it reaches $250 billion.

    From
    http://www.treasury.gov/press/releases/reports/pspa_factsheet_090708%20hp1128.pdf

  14. Alex

    mmckinl – The purchases are not of existing MBS, such as that held by banks, but of future MBS to be issued by Freddie/Fannie.

  15. Anonymous

    **The plan, outlined jointly by the Treasury Department and Federal Housing Finance Agency, also includes a plan for the Treasury to purchase mortgage-backed securities from the firms in the open market, and a lending facility through the Treasury from its general fund held at the Federal Reserve Bank of New York.**

    This is huge. This is the federal government taking over the “toxic waste” in a way that will have an impact not just on Freddie and Fannie, but on the whole market. By “buying” mortgage-backed securities instrad of taking them as collateral, the Treasury does two things at the same time:

    • it takes off the assets and liabilities off the balance sheet of the two companies in a definitive way (rather than temporarily) and assumes, for sure, the associated risk;

    • it sets a price on these securities. This has been the biggest problem to solve the credit crisis: nobody has been willing to set a price on these assets, because of the uncertainty on the real value of the underlying assets (or because everybody could see that they were falling by the day). By setting such a price, thegovernment creates a highly significant precedent – and, in all likelihood, provides a floor to these prices, ie an implicit commitment (or at least the expectation of a commitment) to buy more such securities.
    In doing this, the government is boldly trying to call the end of the financial crisis, set a total price to it, and agree to pay the difference if the cost is higher in the end. This, to me, looks like a full governmental guarantee to the whole banking sector. Of course, a lot will depend on where the price is set to purchase these mortgage-backed assets, but this is still a take-over of the toxic waste by taxpayers, at aprice that may or may not (and, frankly, is highly unlikely to) be right.

    But it’s even worse than that: by providing an additional lending facility on top of that, the government is saying: we’re putting our money (well, yours) where our mouth is – providing further liquidity to the companies and, I presume, expecting them, once the toxic waste has been cleared from their books (which can happen now that there is a floor price), to lend to the mortagage markets again.

    It’s the usual solution of the Greenspan bubble: as soon as one bursts, we blow another one to cover it up and keep the party going a little longer.

    Of course, the goal here is simply to create a boost that lasts until November, and given the kind of weaons used, it’s likely to succeed in that short term goal. Saving the US economy is another thing, given that its fundamental problem is spending beyond incomes – more debt does not cure that, rather the opposite. The twin movements of growing spending and stagnant incomes have to be brought back together. Boosting spending via debt cannot work this time; incomes have to be raised – and for the right people.

    This plan is not about this, it’s about bailing out the financiers that played and lost with other people’s money, and give them a chance to try again. Par for the course, of course.

  16. Anonymous

    As with the UK’s Northern Rock nationalisation, this is only the beginning.

    As you identify, the key point is that the US Treasury is proposing to buy the fake Rolexes, rather than take them as a pledge against a revolving loan.

    This means that as US property prices continue to collapse – which they will, as recession hits the productive economy and “second order effects” kick in – then the Treasury will become an unwilling landlord in a very big way.

    This – without the modern innovation of “jingle mail”, because in those days people bought houses to live in, not to “flip” – is exactly what happened in the 30’s when the Home Owners Loan Corporation refinanced millions of US mortgages, but were nevertheless stuck with 20% of the properties, which they didn’t finally get rid of ’til 1944.

    Don’t forget that even though this move may stop the attrition of bank capital:

    (a) the loans they do make will be at lower income multiples and with sizable deposits; and

    (b) the investors to whom they “outsourced” much of the risk – through securitisation, credit derivatives and credit insurance – are no longer there.

    The outcome can only be a level of property prices way below the levels to which they have already fallen.

    This is going to run and run, and it will constitute a massive political turd sitting on the next President’s desk.

  17. Anonymous

    Would anyone like to take a stab at whether the equity markets are going to react very positively to all this news tomorrow? As I see it, there are some obvious positive actions by Paulson – BUT:

    i) some regional banks get a hit to their capital levels, which is an incremental negative to lending and the economy

    ii) there is still not an explicit guarantee for GSE debt, spreads might not come in as much as expected

    Maybe the positive sentiment will be the over-riding factor and everything will just rally through the roof?

  18. mmckinl

    Nouriel Roubini on flawed govt bailout of Fannie/Freddie:

    “This plan does nothing to restore the long term viability and efficiency of such institutions. It is just a very expensive taxpayers’ funded bailout of the shareholders and creditors of these institutions. Like the action taken in the Bear Stearns case and other recent government interventions and bailouts of private and quasi private financial institutions this is a form of privatization of profits and socialization of losses; it is socialism and corporate welfare for the rich, well connected and Wall Street.”

  19. dh

    Re: ” includes a plan for the Treasury to purchase mortgage-backed securities from the firms in the open market, and a lending facility through the Treasury from its general fund held at the Federal Reserve Bank of New York.**”

    Here we go again. Treasury does not have the right to engage in commerce, because it is not a business and it does not have the authority to become a wall street conduit that exchanges investments from private individuals, pools, corporations or entities. Treasury is out of control here and I hope to God that someone with a brain challenges them on this coup, because if this floats, then we may as well let corporations like wal-mart into The Treasury as well, because they are also too big too fail, too connected to the economy and wall street. If walmart opens to many stores and takes on too much debt, then obviously taxpayers should fund that deficit and help increase the pay for the CEO and then provide shareholders with increased dividends … what kind of a fuc-ed up game is this?

  20. Matt Dubuque

    Attached is the email chain currently ongoing between myself and Martin Wolf of the Financial Times on this subject. I cc'd him on an email to John Dizard. I deleted Martin's header information because this blogger software for this site insisted on treating it as an unacceptable HTML tag.

    Oldest email is at the bottom…

    Martin, I've passed the Bar stateside and have been a market maker in derivatives as well.

    Even Justice Scalia is adamant on the legitimacy of proceedings brought under such a "fraud on the market" theory.

    UK law here is dramatically different than the USA.

    Additionally, thousands of municipalities have purchased these securities for their pension plans. Every local district attorney in these areas therefore has legal jurisdiction to bring criminal charges.

    There is NO possible reason for this accounting change OTHER than materially misleading investors.

    The legal framework in the UK requires a dramatically different analysis.

    Matt Dubuque

    — On Sun, 9/7/08,
    Date: Sunday, September 7, 2008, 9:08 AM

    Sounds right to me. But that is because it is common sense.
    The practices in US mortgage origination in recent years (fraudulent self-declaration of
    income, exaggerated valuations and so forth) seem to me to
    have been clearly fraudulent. Yet it appears they are not. So maybe
    what I think obvious isn't.

    Martin Wolf

    Matthew Dubuque <

    To: John Dizard

    martinwolf@ft.com

    07/09/2008 16:57 Subject:
    Grounds for INDICTMENT of Senior GSE Management

    Please respond to

    mdubuque

    John-

    HERE IS THE FRAUD, which I, as someone who has passed the
    Bar, am convinced
    that any Attorney General of any state could easily obtain
    an indictment
    against any person connected with or who ratified the
    decision below.

    THERE IS NO RATIONAL REASON for the accounting change
    described below OTHER
    than to intentionally deceive the investing public.
    That's a felony.
    Period. No exceptions.

    From Today's NYT:

    http://www.nytimes.com/2008/0907/business/07fannie.html?hp

    "Finally, regulators are concerned that the companies
    may have
    mischaracterized their financial health by relaxing their
    accounting
    policies on losses, according to people familiar with the
    review. For
    years, both companies have effectively recognized losses
    whenever payments
    on a loan are 90 days past due. But, in recent months, the
    companies said
    they would wait until payments were TWO YEARS late. As a
    result, tens of
    thousands of loans have not been marked down in value.

    Matt Dubuque

  21. ruetheday

    Anonymous said: “This means that as US property prices continue to collapse – which they will, as recession hits the productive economy and “second order effects” kick in – then the Treasury will become an unwilling landlord in a very big way. “

    Excellent point. What happens when some of the underlying mortgages default? The government becomes the property owner. That opens up all sorts of thorny political issues (cue campaign ads of federal agents kicking consitutents out of their houses) that no one in Washington wants to deal with.

    Again, this whole “plan” is predicated on the belief that the market is going to turn itself around on its own soon and we just need to give it a little time and funding. When that assumption turns out to be untrue in a year or so, we’re back to square one but the problem will be even bigger.

  22. Anonymous

    Aug. 22 (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.”

    Fix this or we will crush your economy like a bug round eyes. The US empire is no longer in charge of it’s own destination there in nothing good about this bailout.

  23. Matt Dubuque

    Etc.—

    In terms of whether today’s announcement is a “credit event” in terms of CDS payments, the language varies WILDLY from swap to swap. No boilerplate language whatsoever.

    You have to examine EACH SWAP individually because they are literally ALL OVER THE MAP as to whether this conservatorship is an “event”.

    No easy answers.

    Full employment for securities lawyers.

    Matt Dubuque

  24. etc

    matt dubuque: “In terms of whether today’s announcement is a ‘credit event’ in terms of CDS payments, the language varies WILDLY from swap to swap. No boilerplate language whatsoever. You have to examine EACH SWAP individually because they are literally ALL OVER THE MAP as to whether this conservatorship is an ‘event’.”

    That is true, and I never said otherwise. I said it “sounds like” Treasury’s plan didn’t cause a credit event for CDS’ referencing FNM or FRE securities. My reasoning was as follows. I can’t believe the administration would intentionally execute a plan that would trigger (or would have significant risk of triggering) a credit event under a material amount of those CDSs. Consequently, I expect that Treasury’s outside counsel tried to take a representative sample of the CDSs and design a plan that wouldn’t cause such a credit event.

    Maybe they messed up on this issue. No one bats a 1000. Not even Robert Scully and Rodgin Cohen. But I wouldn’t bet that they did on an issue this important.

  25. S

    Is trhe line for the MBS exclusive to MBS or will it include GSE debt? This may be a back door way of saying to the Sovs hey, we are a buyer of your debt?

  26. Matt Dubuque

    Etc.

    Aline van Duyn had an article on this very issue within the last 10 days over at the FT (decisively the world’s best financial newspaper) and concluded that because so many (clearly not all) credit default swaps SPECIFICALLY listed conservatorship as a “credit event” this option for the future of the GSEs could be ruled out.

    She’s pretty savvy, a lot more so than Gillian Tett or anyone I know of at the WSJ.

    It just looks like the accounting fraud was so widespread (i.e. not recognizing losses for 2 years) that they were FORCED to choose from a menu of horrific options.

    Matt Dubuque

  27. Matt Dubuque

    Etc.-

    For your convenience, here is the August 29 analysis by the FT of the precise issue you address, demonstrating the heterogeneity of CDS contracts with respect to conservatorship precluding the choice of conservatorship as a “good option” for the GSEs.

    The clear inference is that, because of the circumstances, this was chosen as the “least horrific” option….

    http://tinyurl.com/5of4xh

    Matt Dubuque

    Derivatives law sheds light on the financial ripple effect

    By Aline van Duyn

    Published: August 29 2008 03:00 | Last updated: August 29 2008 03:00

    Any keen junior official at the US Treasury who wanted to impress the big boss should go and spend some time with derivatives lawyers.

    The reason is this. The terms of derivatives contracts shed vital light on what is, or what is not, viable when it comes to solving problems in the financial system. And there are plenty of those around.

    The biggest problem the Treasury has to grapple with is Fannie Mae and Freddie Mac, the two mortgage financiers whose difficulties are casting an enormous shadow over the capital markets and the broader economy.

    One option that has been mentioned is to place Fannie or Freddie into conservatorship – the equivalent of the government taking it over. Although akin to pressing the nuclear button, and probably not imminent, it is nevertheless a potential outcome.

    Yet this could bring up fresh problems, beyond the pain that equity investors would have to endure.

    Fannie and Freddie are very heavy users of interest rate derivatives, mainly swaps. Indeed the two mortgage groups have entered into nearly $2,500bn worth of interest rate derivatives contracts, according to their accounts.

    In essence, these are tools for hedging interest rate exposure – which is particularly important in the mortgage business, where changes in interest rates can prompt early repayments. Interest-rate swaps are, by the way, regarded as safe, routine tools, not exotic or potentially toxic. The huge nominal amounts that the mortgage groups have outstanding are a little misleading – many of the contracts cancel each other out.

    Nevertheless, the banks that have entered into these derivatives trades have the right to cancel them if there is a bankruptcy. This is broadly defined in swaps contracts, and includes becoming “subject to conservator”.

    If a bankruptcy is triggered, the banks could come calling for any in-the-money swaps, which would add hundreds of millions, if not billions, of dollars of claims to Fannie and Freddie’s problems.

    Conservatorship should, therefore, probably be struck off the list of options, or at least have some kind of health warning next to it.

    The presence of derivatives “stakeholders” in financial restructuring has been a growing phenomenon for companies that face bankruptcy. Restructuring has become more complex in the past decade as more types of capital have emerged. Exactly who ranks where may not be clear, and fortunes can be lost or won playing this game.

    Credit derivatives have entered the picture, though more as a ghost than as a real-life guest. Investors can gain a seat at the creditors’ negotiating table by buying bonds. But they could back an outcome that may benefit them as credit derivatives holders, even though they rarely have to disclose such positions.

    Other examples can be found in the continuing saga of the bond insurers, one of which may yet be sunk by potential losses on credit derivatives.

    “There is a growing awareness of the fact that the derivatives markets are very large and they need to be taken into account in any workouts,” one senior banker who is immersed in these issues told me this week. “The law of unintended consequences can have some quite dramatic and severe outcomes through these derivatives.”

    Indeed. Warren Buffett a few years ago famously described derivatives as ticking timebombs and weapons of mass destruction. Just as a bondholder has a claim on a company, so does a derivatives counterparty. It is as simple as that. Yet understanding these claims, which are often shrouded in dense legal documents, is far from easy.

    By spending time with derivatives lawyers the ambitious Treasury official might be able to come up with a list of solutions that still do not work. But knowing what is not an option – or understanding complicated consequences that can have ripple effects across the markets – can bring you one step closer to knowing what could work.

    Aline van Duyn is the FT’s US markets editor

  28. HoosierDaddy

    So when do we get AutoMac or DetMac to make sure the value of SUVs doesn’t fall?

    Hades, the automaker lobbyists are already in town. May as well be “green” and save them an extra trip.

  29. Anonymous

    Matt Dubuque,

    You certainly know a lot about this stuff.

    You haven’t passed the bar by any chance, have you?

  30. doc holiday

    Yah know,

    Ive been bitching about Treasury and how they can’t be part of commerce, right, well taken a step further, Treasury realistically doesn’t have a license to trade securities, if it dos and they engage in commerce, then guess what, they have to pay taxes, just like Al Friggn Capone, and they have to have a business license and file SEC docs to support what they are doing , and yah know what, I dont think they care and I think this either the mafia running America or some new twisted form of government that is not connected to The US Constitution and all those fake-ass Senators and Congress men are guilty of treason!

  31. etc

    matt dubuque: “Aline van Duyn had an article on this very issue within the last 10 days over at the FT (decisively the world’s best financial newspaper) and concluded that because so many (clearly not all) credit default swaps SPECIFICALLY listed conservatorship as a “credit event” this option for the future of the GSEs could be ruled out.”

    If you’re saying you think Paulson intentionally risked some kind of cascading series of insolvencies for money center banks, then I disagree. I don’t think Paulson or Bernanke have the stones to risk that. I think they would’ve done something else, like maybe have OFEO require the companies to raise an amount of capital so large that Treasury was the only possible source, and that gave Treasury the votes to replace the boards of directors.

    Perhaps you’ve bought a lot of CDS positions that pay off if there’s some kind of doomsday event (on a highly leveraged basis), and need to stir the pot so some people buy them off you. You ought to post on a board populated by members of the tin foil hat brigade. Not many of folks like that read this blog.

  32. Anonymous

    Congress already gave their blessing to this bailout and have oversight. The only possible recourse would be a Constitutional question. Looks to me that the Federal Reserve is the go between acting as the agent and directed by the US Treasury which has used the Fed Reserve as a front (with their own accounting rules) since conception. Nothing new. Nothing to see. Please move along, back to your government owned housing.

  33. Anonymous

    Chrysler was a bailout, this is an active brokerage business that is dynamic and operational, as it works for wall street and not taxpayers. Bailouts are clear cut engagements that use bonds, this is fraud when the government gets into the business to manipulate commerce.

  34. Matt Dubuque

    Etc.-

    I don’t have any positions with orany interest in GSEs, either short or long. My finances are set for life.

    One of the problems with the OFEO scenario you mention (which is otherwise plausible) is the same as the difficulty with Soros’ otherwise plausible plan for mortgage writedowns.

    Any time you choose an arbitrary figure out of the air for a capital infusion, given the overall market collapse, you shortly need to come begging for more. Look at how Merrill and Lehman keep going to the markets hat in hand. It’s an addictive process.

    And that process diminishes your credibility. I think Paulson and Bernanke recognize that.

    Paulson said he wanted a bazooka to defend the GSEs.

    In an nuclear war battlespace, a bazooka is as worthless as a pistol.

    Matt Dubuque

  35. Anonymous

    The sole positive aspect I see in this massive ratcheting up of moral hazard is this portion of Hank Paulson’s statement:

    “These two institutions are unique. They operate solely in the mortgage market and are therefore more exposed than other financial institutions to the housing correction. Their statutory capital requirements are thin and poorly defined as compared to other institutions.”

    Exactly the point I’ve been hammering on in past comments here. Well capitalized financial institutions typically have capital representing 8 to 10% of assets. An undiversified portfolio consisting of 100% mortgages is even riskier than the usual bank portfolio. How could it possibly be prudent for GSEs to hold 1.5% of assets as capital (theoretically — it seems actual capital, with more conservative accounting assumptions, was closer to zero)?

    What bothers me is that just days ago, the GSEs and their regulators were all singing the chorus that Fannie and Freddie were adequately capitalized, if not overcapitalized. Where is the accountability for being flat-out wrong? Where is the accountability for flat-out lying their asses off? I want to see some heads roll. Instead, Mudd and Syron get consulting contracts.

    So typical of the ‘government-business partnership,’ isn’t it? All involved in the greatest debacle in history congratulate themselves on their bold, thoughtful rescue plan, carried out with other peoples’ money. Who knew that heroism came so cheap? Gold stars for all!

  36. Anonymous

    NEW YORK, September 7 — U.S. Treasury Secretary Hank Paulson’s announcement today that he is unilaterally appointing Carlyle Group advisor David Moffett to replace Richard Syron as chief executive of Freddie Mac is more than a little ironic, and troubling. The Carlyle Group invested in and lost on subprime mortgage, it admitted earlier this year. In fact, Carlyle invested in bonds issued by Freddie Mac, as well as Fannie Mae.
    In March 2008, the Carlyle Group’s mortgage-bond fund, having received more than $400 million in margin calls since earlier in the month, said it couldn’t reach an agreement with it lenders, who would “promptly” take over all of its remaining assets. Through March 12, the company had defaulted on over $16.6 billion of debt. On the news, the dollar fell to the weakest since 1995 against the yen and a record low versus the Euro. How then, sources are asking Inner City Press, can Moffett be put in charge of Freddie Mac?

    In fact, Carlyle beyond its investments in military contractors has been accused of other slash and burn tactics, for example by workers at the nursing home chain Manor Care. Its buy-out of Home Depot’s contractor supply unit nearly fell apart, as its lenders balked.

    Moffett previously served as chief financial officer of U.S. Bancorp, which beyond its own subprime lending was a 25% investor in the now-bankrupt subprime lender New Century. When Inner City Press investigated U.S. Bancorp’s stake in New Century, the company argued to the Federal Reserve that despite having two seats on the board of directors it did not control the lender. The word subcrime began to become applicable. The Fed demurred, and eventually the stake was sold off. But Moffett’s companies’ involvement in the subprime field is hardly a basis for confidence in him to lead at Freddie Mac. In fact, the choice calls into question Paulson’s judgment.

  37. Matt Dubuque

    I hope no person is arguing that the Treasury has no authority to purchase securities because it isn’t in the Constitution.

    If so, please recall that the Air Force is not mentioned in the Constitution either. They didn’t have airplanes back in 1787.

    Such a specious argument would also demand immediate abolition of the Air Force.

    Treasury is acting well within the statute Congress recently passed and all of the conservative Supreme Court justices such as Scalia and Thomas and Roberts (as well as the others) would DECISIVELY allow such conduct.

    Just read some of Scalia’s opinions on legislative intent. If it’s spelled out in the legislation, Scalia gives an EXTREMELY wide berth to the will of the people, expressed through Congress.

    Surely you are not seeking activist judges here?

    And the Antonin Scalia and Clarence Thomas write a unanimous opinion for the Supreme Court saying its legal, it’s perfectly legal as far as I’m concerned.

    Matt Dubuque

  38. Matt Dubuque

    Anonymous, when you said:

    “How could it possibly be prudent for GSEs to hold 1.5% of assets as capital (theoretically — it seems actual capital, with more conservative accounting assumptions, was closer to zero)?”

    This is precisely my point. HYPERLEVERAGING, according to BOTH Bernanke and Buiter play a central role in this fiasco.

    In terms of accountability, the accounting rule change I describe at the top of this thread, where losses on mortgages were not recognized until TWO YEARS after they began, is subject to criminal prosecution.

    We’re talking felonious manipulation of material information to sell publicly traded securities. I’m convinced we have enough information to obtain indictments in any governmental jurisdiction whose pension fund purchased GSE assets, as I set forth near the top of this thread. Martin Wolf of the Financial Times, despite some reservations, has broad areas of agreement with that position.

    Matt Dubuque

  39. etc

    matt dubuque: “I don’t have any positions with orany interest in GSEs, either short or long. My finances are set for life.”

    Perhaps, but you’re still talking your book. Promoting doomsday would seem to help you promote your documentary “The Crash of 2008 – Hyperdeflation” at Sundance.

    Despite that, I do agree with your comments on your website that big cap stocks will fall a good bit late this year or early next year due to many companies failing to meet earnings expectations. And I’ve laid bets that way, expecting it’ll be a catalyst for investors to favor companies with financial strength.

    That said, I think you’re way too pessimistic. I think we’ll see a recession like in the early 80’s, which was bad but not the end of the world. And the US has much more room to run deficits than the UK, Japan, and a lot of other economies. And the US has programs to help people that didn’t exist in the 30’s like the earned income tax credit, headstart, school lunch programs, and so on.

  40. Anonymous

    It’s a more basic question, like, can the government socialize any part of the housing industy and inject themselves at will competing in interstate commerce? Funding was one thing but ownership is another.

    I understand trying to stabilize, backstop, prevent, insure some pending world meltdown but that’s not how free markets work. In a free market the meltdown occurs unabated.

  41. Anonymous

    Does this mean that every int’l central bank, public and private pension fund, sovergn wealth fuund mutual fund that owns toxic debt now has a market with instant liquidity for their securities they can’t get bids for?

  42. ruetheday

    Anonymous said: “What bothers me is that just days ago, the GSEs and their regulators were all singing the chorus that Fannie and Freddie were adequately capitalized, if not overcapitalized.”

    Here’s a thought. Five weeks ago, our esteemed regulators (going on publicly available information) thought a capital injection would be all that was needed. A few weeks go by, they hire Morgan to do a more thorough analysis, and holy shit it’s worse than they thought and the government needs to take them over. What happens when their guys get to see the REAL numbers without the execs throwing up smokescreens? Receivership?

  43. Matt Dubuque

    etc.-

    Here are a few of my core beliefs.

    As stated on my website, I simply don’t believe the Fed can control markets. That was in the 60s.

    The markets are far larger than the Fed for such a thing to occur.

    By logical extension, if the Fed cannot control markets, Matt Dubuque, with far less influence than the Fed, cannot either.

    I have several documentaries in the queue and this is the only financial one. With respect to winning awards for my films, my chances of doing so seem far greater using less arcane subject matter.

    In good faith, I have concluded that there are two principal causes of this financial train wreck:

    1. The false assumption, present in all valuation models for 480 TRILLION dollars of derivatives that prices are normally distributed, i.e. follow a bell-shaped curve, and

    2. Amplification of that fatal mistake through HYPERLEVERAGING, which leaves no margin for error.

    Now that’s a pretty math-intensive thesis for a documentary. Most people don’t even know what a derivative is, much less how derivatives valuation models should reflect more Cauchian, rather than Gaussian, distributions.

    Remember, we live in a banana republic. A nation that…. oh never mind.

    For some reason, I have been blessed with quite a number of fantastic ideas for documentaries, all fully developed. Only this one deals with finance.

    I stopped posting excerpts a few months ago for the documentary you refer to a few months ago and have shifted my focus to other films that have much broader appeal and are actually very cool. Documentaries that unify people, heartwarming stories. Great stuff.

    Many times in my life I’ve had the distinct feeling that I would LOVE to be mistaken.

    If I am mistaken about the severity of our financial plight, all will be peaches and cream. That’s obviously a preferred outcome for me!

    But in terms of understanding the internal dynamics of the Fed, I’ve been at it for 26 years and have an extraordinary command of precisely what they are debating and where they are going. Additionally, I honestly don’t know any person who has a better feeling for what’s going on in the Treasury market. It’s not braggadoccio, I just don’t know of another person with my expertise in the area.

    Given those fundamental tools and my use of them, the most likely scenario for me is a profound global downturn over the next two or three years, with a downward break likely to occur no later than February when the next wave of AUDITED financial reports are released.

    I’d love to be wrong. But it seems clearly likely I am correct.

    Matt Dubuque

  44. Elizabeth

    I’ve been mulling this deal around all day and these are the two things I can’t figure out.

    1) Why did the govt subordinate themselves to the sub debt????? You still have some issues of serious moral hazard when you protect sub holders as well as put tax payers at more risk than they need to be.

    2) To achieve a 10% runoff, for all practical purposes, FNMA and FHLMC will have to do no new business for 8 years or something like that. In 18 months, some mysterious financial institutions are going to have to come out of the woodwork and takeover their share of business. Who the heck is going to underwrite all the mortgages? Will there be an equity value left or just liquidation value????

  45. Anonymous

    OKAY Guys – So for the more feeble minded such as myself, do or do not these conservatorships constitute CDS triggers? Or is the truth that one must read each CDS instrument individually because there’s no standard?

  46. bustafunk

    etc.,
    I don’t know who the hell this matt guy is, or for that matter, who you are, but I do know this, the cupboard is BARE. Not cashflow bare, but fundamentally bare. Total debt/gdp ratio is a full 100% higher now than in 1929. I (and most of my friends) made 300K plus the last 4 years, and this year we might clear 60. And not connected in housing either. You think I am going to pay taxes for years and years??? Self reinforcing spiral to the downside brother, and its a doozy. Not trying to be rude, just realistic.

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