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Comment Jim was on Bloomberg TV discussing Fannie Mae and Freddie Mac. If you missed the interview, you can watch it by clicking on the picture above. To see any of our recent interviews, click on the open button.
Jim argued that the situation is not going to get better and the federal government will be forced to nationalize them.
Fannie Mae and Freddie Mac have a business model that is causing them to lose money and bleed capital. By explicitly guaranteeing their debt, the U.S. Treasury is not allowing these companies to radically change their business model to stop the losses. By having OFHEO lower the net capital requirements and Congress increasing the conforming limit to $730,000, they are accelerating the GSE’s demise by having them take on more risk with lower capital requirements. Unless home prices stop going down, and not merely showing a slowing of the declines as Case-Shiller reported today, the GSEs will continue to bleed until they are nationalized.
Technically they are still properly capitalized, as explained on August 8 (scroll down a bit). But as also explained on August 20, Freddie Mac is already insolvent by the measures of “fair value” and Tangible Book Value. Fannie Mae is not far behind.
Nationalization seems to be the next step.
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The Financial Times – John Dizard: State injection for Fannie and Freddie will offset pain
Fannie Mae and Freddie Mac need to be nationalised, in the sense that the federal government injects capital in the form of preferred equity and direct credit support, wiping out the existing common. I believe it is critical that that takeover leaves the privately held preferred stock of the government-sponsored enterprises in place. Preserving the value of GSE preferred issues is very much in the taxpayers’ interest, as it makes possible the recapitalisation of the rest of the banking system. Most of the discussion of the need for a federal takeover of the GSEs has concerned their credit losses on subprime and Alt-A paper. However, even if a private recapitalisation could be done to offset those, the GSEs would not have sufficient capital to handle the long-term risk of the maturity mismatches on their highly leveraged balance sheet. Let’s say there’s a great economic recovery, housing prices stabilise, and the interest rate curve becomes more normal. The rise in long-term rates would lead to an extension of the maturity of mortgage portfolios, which would need to be offset by hedging activities. Significant declines in the long end would also need to be hedged, as homeowners refinanced. I don’t believe the interest rate swaps market will have the capacity or willingness to take on that risk at any payable price. One way or another, these institutions will spend a considerable time with negative equity. Again. The only way to handle that is with government ownership. No doubt there are bankers and lawyers explaining all this to the Washington “leadership”, in the respectful, but urgent, tones trust and estate lawyers use when telling dim heirs that they need to sign a document lest Mummy’s bequest become valueless. It could take a little while for the political managers to accept that they need to shred yet another set of talking points. -
Reuters – Gross, Fuss say any new GSE deal needs Treasury
Two of the biggest U.S. bond investors said they would get involved in a capital raising by Fannie Mae and Freddie Mac as long as the U.S. Treasury participates in the new deals. But Bill Gross, chief investment officer at Pacific Investment Management Co., and Dan Fuss, vice chairman of Boston-based Loomis Sayles, disagree on what shape any deal with Treasury should take, according to separate interviews on Friday. Gross would be drawn to a straight preferred stock offering similar to securities sold by Fannie Mae and Freddie Mac in raising capital this year and last, while Fuss wants an offering of convertible debentures. “We would buy preferred stock subject to significant Treasury participation and an attractive yield,” Gross told Reuters by email. -
The Wall Street Journal – J.P. Morgan Could Face Fannie, Freddie Writedown
J.P. Morgan Chase & Co. could post a write-down of $600 million or more on the value of its holdings of Fannie Mae’s and Freddie Mac’s perpetual preferred stock as their value continues to sink. The potential losses come weeks after J.P. Morgan disclosed it took another $1.5 billion write-down as a result of the subprime-mortgage rout. The firm disclosed Monday that it held about $1.2 billion of Fannie and Freddie’s perpetual preferred stock and that it has lost some $600 million in value this quarter. The securities are held in J.P. Morgan’s investment portfolio. Potential losses on the securities for the third quarter are difficult to determine, given the significant volatility in their market value. Fannie sold $7 billion of perpetual preferred stock last fall in a round of capital raising, while Freddie sold $6 billion of such stock and it has lost more than half its value.