Today the Secretary of the Treasury announced how the bailout of the insolvent Freddie Mac and Fannie Mae is planed to take place. These are the priorities:
Since this difficult period for the GSEs began, I have clearly stated three critical objectives: providing stability to financial markets, supporting the availability of mortgage finance, and protecting taxpayers
Did you notice the sequence of those three objectives?
I attribute the need for today’s action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither.
WTF – in 2006 the agencies, who are supposed to finance sound mortgages and have done so for some 70 years, started to buy ALT-A loans where the borrower provided no income documentation. The also began to hedge risk through derivatives. This under the eyes of their regulator, the Treasury and Congress. It was certainly not the "business model embedded in the GSE structure" but the greed of the management and the shareholders and the willful blindness of the watchdogs, that drove F&F over the cliff.
Paulson’s provides a four step plan. As general strategy F&F will still slowly increase their MBS holdings into 2009 and are supposed to shrink it in and after 2010.
The immediate financial measures are threefold:
First, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth.
The taxpayer will buy fresh stocks from these companies and provide them with enough capital to prevent their formal bankruptcy. If they make more losses, the taxpayer will buy more stocks and delute the value of stocks it bought before. The current preferred stockholders will have to take some of the now occurring losses. This will kill off many smaller banks who have their capital invested in such shares.
The second step Treasury is taking today is the establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.
The U.S. taxpayer will borrow money from China and lend it to F&F because China is no longer willing to lend to them directly.
Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS.
This is the PIMCO provision. PIMCO, the huge bond fund that provides fixed income for many U.S. citizens, has bought quite a lot of F&F (GSE) Mortgage Backed Securities (i.e. toxic waste) it now wants to sell. The chief of PIMCO, Bill Gross, made a lot of noise over this last week as he was afraid to lose money on them. Now the U.S. taxpayer will buy these MBS.
Through the four actions we have taken today, FHFA and Treasury have acted on the responsibilities we have to protect the stability of the financial markets, including the mortgage market, and to protect the taxpayer to the maximum extent possible.
Again, notice the sequence.
The Treasury action came this weekend because Russia and China were recently dumping huge amounts of F&F MBS. They fear that the implicit government guarantee for these bonds would not hold up. Paulson today still did not give an explicit government guarantee but pushed that task to Congress.
There is not much in Paulson’s acts that will give China and Russia a more secure feeling about their F&F MBS holdings. I therefore expect them to continue their sell off of these papers. That means that the trouble over these agencies is far from over.