“Summer” Rerun: Thin Gruel in Paulson Statement re Fannie, Freddie; Fed Opens Discount Window

This post first appeared on July 13, 2008

For those looking for some concrete action (which was what many market participants hoped for), Paulson issued a statement that amounts to hand waving. Full text from Bloomberg:

Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.

GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure. In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately.

First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.

Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.

Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer. Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator’s process for setting capital requirements and other prudential standards.

I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.

One can assume that the per the bouquet to Congress, the Treasury ascertained that it lacks statutory authority to go beyond the support it is permitted to offer the GSEs established in their charters (credit lines of $2.25 billion, which in the late 1960s was real money). As jck at Alea points out:

So the original, 40 year old, credit line was 2.25/15 = 15% of outstanding debt, to go back to that ratio requires $231 billion for fannie and freddie…

Probably more important is that the Fed has opened the discount window to the GSEs, but this again looks like symbolism rather than substance, since accessing the discount window is seen as a sign of weakness (that was one of the reasons for the establishment of the Term Auction Facility, which accepts the same types of collateral on the same terms as the discount window, but provides longer-dated loans and most important, the identity of borrowers is not disclosed).

I have been a skeptic of whether the so-called Plunge Protection Team exists (or more accurately, whether it engages in active market support operations as the conspiracy minded believe).

Given the weakness of the steps taken so far, tomorrow has the potential to reveal footprints if such activities take place.

One thing I do expect to happen is that the powers that be will lean on various financial institutions to bid at the $3 billion Fannie sale of short-dated bonds tomorrow. That is a no-brainer and treads on the margin of what one might consider PPT type manipulation.

Firmer evidence would come via odd trading patterns in the S&P. On January 22, the Dow fell nearly 400 points on open, and the S&P also tanked, I don’t have access to detailed historical charts of intraday pricing, but the S&P looked as if there was a massive support bid (if I recall right, at 1255). It wasn’t spiky, which is what you’d expect from normal bottom fishing buys.

That was only one data point, and there may have been some bizarre technical trigger for bids at that level. But it looked very unnatural. If we see a similar pattern, Monday, my suspicions will increase.

Update 8:50 PM: Asian markets save Australia have opened up and the dollar has rallied a tad, so the cheery words and hand waving may have worked for now.