Bailout begins for Freddie Mac, Fannie Mae

[J]

New York Times link

Rescue Sought for Fannie and Freddie

By STEPHEN LABATON
Published: July 14, 2008

WASHINGTON — Alarmed about the sharply eroding confidence in the nation’s two largest mortgage finance companies, the Bush administration will ask Congress to approve a rescue package that would give the government the authority to buy billions of dollars in stock in Fannie Mae and Freddie Mac and also lend to the companies to meet their short-term funding needs, people briefed about the plan said on Sunday.

Separately, the Federal Reserve voted on Sunday to also open a lending facility for Fannie Mae and Freddie Mac, if they need emergency capital. The two companies would be able to post their own securities as collateral.

The plan calls on Congress to give the government the authority over the next two years to buy an unspecified amount of stock in the two companies. Over the same period of time, it would permit the companies to have greater access to the Treasury, by expanding the credit line that each company has from the Treasury. Each company now has a $2.25 billion credit line, set nearly 40 years ago by Congress. At the time, Fannie had only about $15 billion in outstanding debt. It now has total debt of about $800 billion, while Freddie has about $740 billion.

Today the two companies also hold or guarantee mortgages valued at more than $5 trillion.

As part of the plan, the administration will also call on Congress to raise the national debt limit, people briefed on the plan said. And it will ask Congress to give the Federal Reserve a role in setting the rules for how big a capital cushion each company must hold. Giving the Fed a consulting role in the companies’ oversight is seen as yet another way to reassure nervous markets.

Treasury officials declined to comment on the plan but indicated that a statement would be issued later on Sunday. It was described by lawmakers and officials at other agencies that have been briefed on it.

They said that the Bush administration was hoping that Congress would adopt it quickly as part of a measure intended to help the housing markets and overhaul the regulation of Fannie and Freddie. Last Friday, the Senate approved the measure, and the House is hoping to take it up this week.

Announcement of the plan on Sunday evening was intended to send a sharp signal to both stock markets and debt markets that the government was standing behind the beleaguered companies.

Throughout the weekend, senior officials from the Treasury and the Federal Reserve closely monitored preparations by Freddie Mac to raise money help meet its short-term funding needs. Top officials spent Saturday and Sunday being briefed on Wall Street’s appetite for a $3 billion debt offering by Freddie Mac that was set for Monday. Officials said they were watching to see if the steep declines last week of Freddie and Fannie stock would spill into the debt market and undermine the confidence of lenders.

Fannie and Freddie have grown to become central to the nation’s housing markets. They buy mortgages from banks and other lenders, hold some of them, and sell others in the form of mortgage backed securities. Together, they own or guarantee nearly half the nation’s mortgages. In recent months, the stocks of the two companies have plunged as a wave of foreclosures has eroded confidence in the companies.

The credit line provided by the Treasury to the companies has always been seen by the market place as evidence that the two companies would be rescued by the government if they ever encountered severe financial problems. Yet for many years, a steady of stream of leaders from the Federal Reserve and to officials from Republican and Democratic administrations has denied the existence of a so-called “implicit guarantee.” Those who denied the existence of the guarantee included Treasury secretaries Robert Rubin, Lawrence Summers and Henry M. Paulson Jr., and Federal Reserve Chairmen Alan Greenspan and Ben S. Bernanke.

The implicit guarantee was a useful device both for the companies and the federal government. It has enabled the companies to get money in the debt markets at rates far lower than other companies and close to the same as treasury securities. At the same time, the Federal government did not have to record on its budget any significant liabilities for the large subsidy it was, in effecting, providing to the companies. Yet it also raised concerns among critics, who said it was unfair to rival companies and that it promoted a management laxity since executives knew that the companies could always count on a hand from the government if they began to falter.

Now, in the face of market turmoil in recent days, a quiet yet dramatic policy shift has occurred. Government officials no longer deny the existence of a guarantee. Instead, senior officials at both the Fed and the Treasury have been talking in recent days of possibly taking steps to “harden the guarantee.”

Motivating the change was the central role of the two institutions and the depth of ownership in the paper they have issued. Every major bank, and many mutual funds and pension funds and foreign governments, hold significant amounts of securities issued by Fannie and Freddie, which have been viewed over the years as being almost as safe as treasury securities. A default by either one of the companies could be catastrophic for the financial system.

And so it begins. How this particular piece of the puzzle is handled will almost certainly be the key to how bad things become in the future.

[Admiral Valdemar]

So, the government has basically accelerated the demise of the US economy. It's going to be interesting seeing how they pay off these debts. Or, rather, don't. The addition of another five-trillion in debt to the US public's tab is going to seriously undermine their economic position. There was already no hope of paying off such a growing deficit, even with 100% taxation rates. Now, it's a matter of eroding any confidence left with the dollar even quicker.

[Kanastrous]

the two companies would be able to post their own securities as collateral.

Does that mean that companies whose stock can't be worth much - if they're in so much trouble - are being permitted to use their own not-worth-much stock, as collateral for a tax-money bailout...?

[Darth Wong]

the two companies would be able to post their own securities as collateral.

Does that mean that companies whose stock can't be worth much - if they're in so much trouble - are being permitted to use their own not-worth-much stock, as collateral for a tax-money bailout...?

One set of rules for the rich, another set of rules for everyone else ... par for the course in American politics.

[J]

Does that mean that companies whose stock can't be worth much - if they're in so much trouble - are being permitted to use their own not-worth-much stock, as collateral for a tax-money bailout...?

Yup, they can now use their own stocks and bonds as collateral for loans from the Federal Reserve Bank. Which gets real interesting since the Fed only has around $25 billion in short term treasury notes left, once that's gone the Fed has to start liquidating its other assets. And that runs the risk of causing a market dislocation, in short, everything goes kablooie!

[Admiral Valdemar]

It's funny. I thought I heard Paulson say, not a million years ago, that the US government would not be bailing out these institutions.

I guess this means he's full of shit. As if anyone with a functioning brain cell would accept the US Govt. would allow these entities to flounder.

[Uraniun235]

And that runs the risk of causing a market dislocation, in short, everything goes kablooie!

Does "everything goes kablooie" include a river of blue blood running in Wall Street? Because if so that would be a pretty sweet silver lining.

[Resinence]

Does "everything goes kablooie" include a river of blue blood running in Wall Street? Because if so that would be a pretty sweet silver lining.

Wasn't there pretty large scale suicides among investors etc during the last depression? Depends how bad it gets' but they seem determined to fuck themselves over.

[Uraniun235]

Does "everything goes kablooie" include a river of blue blood running in Wall Street? Because if so that would be a pretty sweet silver lining.

Wasn't there pretty large scale suicides among investors etc during the last depression? Depends how bad it gets' but they seem determined to fuck themselves over.

I'm guessing those were dudes that lost *everything* without any warning, I'm pretty sure a lot of rich fucks have quietly set aside a pile of cash for if/when everything goes to shit.

And those are the guys whose blood I want to see in the streets of Manhattan.

[J]

Does "everything goes kablooie" include a river of blue blood running in Wall Street? Because if so that would be a pretty sweet silver lining.

Well, I don't know if there'll be a river though I fully expect to see news stories of the scene depicted below.

[J]

I'm pretty sure a lot of rich fucks have quietly set aside a pile of cash for if/when everything goes to shit.

And those are the guys whose blood I want to see in the streets of Manhattan.

Some of them have. Quite a few others are now playing double or nothing. And losing.

[CaptainZoidberg]

Does that mean that companies whose stock can't be worth much - if they're in so much trouble - are being permitted to use their own not-worth-much stock, as collateral for a tax-money bailout...?

Yup, they can now use their own stocks and bonds as collateral for loans from the Federal Reserve Bank. Which gets real interesting since the Fed only has around $25 billion in short term treasury notes left, once that's gone the Fed has to start liquidating its other assets. And that runs the risk of causing a market dislocation, in short, everything goes kablooie!

I'm not economist, but sums of money like 25 billion seem insignificant in the bigger picture US government spending. I mean, if we were facing a *very* serious financial collapse, I don't see why the hundreds of billions that we're spending on military operations couldn't be temporary diverted to bail out banks (yes, I know, it's Bush, but still).

[J]

I'm not economist, but sums of money like 25 billion seem insignificant in the bigger picture US government spending. I mean, if we were facing a *very* serious financial collapse, I don't see why the hundreds of billions that we're spending on military operations couldn't be temporary diverted to bail out banks (yes, I know, it's Bush, but still).

Of course we could do that, pass a new spending bill through Congress and it's as good as done. The problem is it's a lot like giving heroin to a junkie; it doesn't solve the root problem and makes the inevitable crash even worse, that is, if it doesn't kill the addict outright.

It also leads to a bad case of moral hazard, wherein the banks involved will repeat what they're doing now again & again & again, with the costs being born by the people. That means you, via your taxpayer dollars. In effect it's the largest wealth transfer scheme ever dreamed up, and we are all getting shafted.

[Alan Bolte]

$25 billion isn't huge in terms of federal spending, no. But $25 billion is also a drop in the bucket as far as Fannie and Freddie are concerned. This is, necessarily, only the beginning. If the government is determined to avoid either institution defaulting on its debts, then there will be many more bailouts like this one.

[Nova Andromeda]

-I'm confused on some things:

1. What % of the underwritten debt (5T) is bad?
2. When and from who(m?) was this debt bought?
3. What should a poorish scientist do with their money: Everbank currencies, gold/silver/etc, something else?
4. What does a financial collapse look like anyhow? Let's say F&F fail, no longer back loans, and mortages become significantly more expensive.
5. What specifically, does this do to the attractiveness of the dollar. That is, what will the dollar do and why.
6. How bad is this for the various world economies?

[Darth Wong]

The real problem is not the idea of trying to mitigate an economic shock, but rather, trying to do so without clamping down with strict new regulations. I would understand the rationale behind these bailouts if they came with the price tag of losing some of those precious freedoms they've become accustomed to. They need to be put on a leash.

[TheKwas]

Obviously the institutions can't be allowed to fall, some sort of compromise between avoiding moral hazard and destroying the economy for the sake of making an example is needed:

Bailouts and Moral Hazard

Here we are again, just into a Bear (sterns) market and we have to face the fact that Fannie Mae and Freddie Mac are waaaaay to big to fail. A strong case can be made that a bailout will cost relatively little and failure to come to their assistance will cost a lot even when distracted by Gover Norquist's absurd arguments. Here is the video. In defence of the BBC, the accents have gotten a lot better since 1945, no striped trousers on the broadcast at all.

OK so we have to bail out the FM's. However, it is irritating that the people who made this mess obtained tens of millions in compensation doing so. I can translate my populist rage into gametheoryspeak noting that bailouts create moral hazard problems. The US government can't let Fannie or Freddie or even the medium size bad Bear fail. It shouldn't make executives decide to run risks only because they know that if they roll snake eyes, the treasury or the fed will bail them out. So What is to Be Done ?

It seems simple to me (and many many others). The institutions are too big to fail, their officers are vulnerable to bad incentives. The correct policy is to keep the institution from failing in a way which will serve as a lesson to the officers of other institutions.

I think the optimal policy is simple. The chairman of the Fed tells the CEO of To Big to Fail Bank (tbtf bank) that the FED will pick up dodgy assets with face value X if mr CEO picks up dodgy assets with face value equal to 90% of his wealth as reported in the Forbes 500 or 5 years of his (or her hah?) total compensation. Then Bernanke can mention that he is not a shareholder of tbtf bank, but, if the CEO were to say no and the bank were to go bust and he were a shareholder he sure would sue (and presumably win).

Now the CEO can appeal to the 13th amendment and resign on the spot, but he loses if he says yes and loses more if he says no. If he says he is resigning, BB (Ben Bernanke not Big Brother) says his successor will be offered the same deal with the added proviso that CEO I not be paid anything by tbtf bank beyond what CEO I can claim is due to him in court. And so on. BB will get down to someone so poor that he is willing to put 4 years of compensation at risk in order to be CEO.

Unlike the highly compensated officers, that person might even be competent to manage a bank (stranger things have happened).

Angry bear
http://www.angrybear.blogspot.com/

[Col. Crackpot]

the two companies would be able to post their own securities as collateral.

Does that mean that companies whose stock can't be worth much - if they're in so much trouble - are being permitted to use their own not-worth-much stock, as collateral for a tax-money bailout...?

One set of rules for the rich, another set of rules for everyone else ... par for the course in American politics.

that may be so, but if fannie may and freddie mac are allowed to collapse, you can kiss the middle class goodbye.

Both institutions guarantee loans made to lower income individuals. (42% American mortgages) With them removed from the system, interest rates spike sharply, underwriting guidelines become draconian for the average working person. That causes demand for real estate collapses in a massive over correction and home prices become artificially low. People suddenly become "upside down" in their mortgages... the rest, well do you really want to go down that road?

[Darth Wong]

One set of rules for the rich, another set of rules for everyone else ... par for the course in American politics.

that may be so, but if fannie may and freddie mac are allowed to collapse, you can kiss the middle class goodbye.

I'm aware of that. The problem is the lack of accountability in this process. Why isn't anyone being made to pay? Why isn't the government even talking about harsh new regulations?

[ArmorPierce]

The most obvious regulation that should be made is a limit on their debt leveraging. Their debt leveraging is a lot higher than that of a normal bank due to the fact that there is the belief that the federal government would not allow them to fail.

[Col. Crackpot]

One set of rules for the rich, another set of rules for everyone else ... par for the course in American politics.

that may be so, but if fannie may and freddie mac are allowed to collapse, you can kiss the middle class goodbye.

I'm aware of that. The problem is the lack of accountability in this process. Why isn't anyone being made to pay? Why isn't the government even talking about harsh new regulations?

Do you have any idea how hard it is to borrow now Mike?

6 months ago if you had good credit (720 FICO) i could give you $199,999 with no income verification 90% loan to value and up to 65% as a debt to income ratio. Now, if you want 40 or 50 grand I need two years tax returns, 2 years at your current employer, cutoff at 80% LTV and 50% DTI. Prime-1 to Prime

Borderline credit (620+ FICO) 6 months ago same loan 80% LTV 45% DTI
i could broker a deal at prime+1 or 2. Now? fuck you unless you have a 660 FICO, Even then we are going full documentaion and cutting you off at 35% DTI.

Does the government need to regulate? Sure. But the math geeks in underwriting (Iin just about every bank) aren't waiting for Uncle Sam to get off his ass.

[Darth Wong]

Do you have any idea how hard it is to borrow now Mike?

We're in the midst of a crisis right now; it's obviously hard to borrow. But without harsh new regulations, people will do the same stupid shit again sometime in the future.

6 months ago if you had good credit (720 FICO) i could give you $199,999 with no income verification 90% loan to value and up to 65% as a debt to income ratio. Now, if you want 40 or 50 grand I need two years tax returns, 2 years at your current employer, cutoff at 80% LTV and 50% DTI. Prime-1 to Prime

Borderline credit (620+ FICO) 6 months ago same loan 80% LTV 45% DTI
i could broker a deal at prime+1 or 2. Now? fuck you unless you have a 660 FICO, Even then we are going full documentaion and cutting you off at 35% DTI.

Does the government need to regulate? Sure. But the math geeks in underwriting (Iin just about every bank) aren't waiting for Uncle Sam to get off his ass.

Again, irrelevant. You shouldn't give away money to this industry without some strings attached.

[J]

That's not hard, that's just mortgages going back to proven historical norms; fixed rate, full doc, 20% down, 36% DTI, and no frills nor funny business. In other words, a prime mortgage with miniscule chances of defaulting in anything short of a depression.

Does the government need to regulate? Sure. But the math geeks in underwriting (Iin just about every bank) aren't waiting for Uncle Sam to get off his ass.

Oh of course not, they're only a year or two late and shutting the door after the horsies are gone and the barn's burning down. It's not as if they have much choice, they're being slaughtered by the markets on all sides, and now that word is starting to trickle out into the mainstream media they're going be in really deep doo-doo. Can you say "bank run"? IndyMac was hit by one and word is WaMu is suffering a case as well, tomorrow's not going to be fun for them after today's coverage on how their shares tanked 35% in a single day.

[Glocksman]

that may be so, but if fannie may and freddie mac are allowed to collapse, you can kiss the middle class goodbye.

I'm aware of that. The problem is the lack of accountability in this process. Why isn't anyone being made to pay? Why isn't the government even talking about harsh new regulations?

Do you have any idea how hard it is to borrow now Mike?

6 months ago if you had good credit (720 FICO) i could give you $199,999 with no income verification 90% loan to value and up to 65% as a debt to income ratio. Now, if you want 40 or 50 grand I need two years tax returns, 2 years at your current employer, cutoff at 80% LTV and 50% DTI. Prime-1 to Prime

Borderline credit (620+ FICO) 6 months ago same loan 80% LTV 45% DTI
i could broker a deal at prime+1 or 2. Now? fuck you unless you have a 660 FICO, Even then we are going full documentaion and cutting you off at 35% DTI.

Does the government need to regulate? Sure. But the math geeks in underwriting (Iin just about every bank) aren't waiting for Uncle Sam to get off his ass.

That's simply scary.
A year ago my FICO score was 760, despite my $12/hr job simply because I made my payments on time.
That said, I never could have realistically afforded adding a $199k mortgage to my existing debt.

[Col. Crackpot]

Oh of course not, they're only a year or two late and shutting the door after the horsies are gone and the barn's burning down. It's not as if they have much choice, they're being slaughtered by the markets on all sides, and now that word is starting to trickle out into the mainstream media they're going be in really deep doo-doo. Can you say "bank run"? IndyMac was hit by one and word is WaMu is suffering a case as well, tomorrow's not going to be fun for them after today's coverage on how their shares tanked 35% in a single day.

Here is some perspective. Amongst other banks IndyMac was almost universally derided for being a bank that lent to scumbags and degenerates. To equate them with the larger market as a whole is foolish. Many prime and super prime lenders wouldn't even broker out sub-prime paper to them they were so bad. Will there be more collapses? Sure, the stragglers will be culed from the herd.

As for Wamu, they are in FAR better shape than IndyMac. Wamu has 40 billion in liquid assets and a tangible asset to equity ratio of around 8%. Translation: they are far better capitalized than IndyMac.