The rumors floated on Friday regarding Fannie and Freddie turned out to be true. This first bailout proposal, released a few hours ago, has three parts. I say “first” because there is no way that this is going to be enough to save what’s headed our way nor will this be the only time the government will need to ”bailout” F&F.
The U.S. Treasury plans to seek approval for a temporary increase in the line of credit granted to Fannie Mae and Freddie Mac. They will also seek authority to buy equity in either company, and the Federal Reserve voted to allow the New York Fed to loan F&F money, if needed, giving F&F access to the Federal Reserve’s discount window.
The Wall Street Journal says the U.S. Treasury and The Federal Reserve are doing this mainly to boost confidence in F&F, not necessarily because any of this is needed, which to me seems to be a flat out lie.
The weekend move means that Fed Chairman Ben Bernanke, who has been steadily accumulating authority as the U.S. grapples with the financial crisis, will have even more power. The Treasury envisions the Fed working with the mortgage giants’ regulator to help prevent situations that could be a risk for the entire financial system. The move builds on Treasury’s broader goal of remaking financial regulation to give the Fed broader influence over financial-market stability.
I’m not sure if we’re suppose to be happy or scared at the thought of Ben Bernanke accumulating more power. Maybe what’s really going on is some preemptive planning due to known or unknown possibilities that tomorrow’s auction of Freddie Mac debt doesn’t go well.
The Sunday move was designed in part to head off fears about Monday’s auction of Freddie Mac notes. While small, the planned sale had assumed an outsized importance as a test of investor confidence. Freddie should be able to find buyers for its three- and six-month notes, market analysts said. But there is a chance that some financial institutions and investors may demand higher-then-usual yields.
Similar Freddie and Fannie notes that are currently outstanding yield around 2.5%. If weak demand for Freddie’s auction leads to sharply higher yields on the new notes, that could trigger a selloff across a wide range of debt issued by the companies, some analysts said. But most said such a scenario is unlikely.
I’ve been glued to the web, the radio, and my phone since Friday evening reading, listening, and talking about this with friends and colleagues. If the federal government choses to provide (the implied) government backing for bondholders, then the United States increases our national debt by 5 trillion dollars which would have a profoundly negative impact on the value of the dollar and potentially bankrupting the U. S. economy. If the federal government chooses to do nothing and F&F are forced to mark their portfolio closer to market value and sell off assets to accumulate capital, then the true value of what’s in the bag becomes known. The secret will be out and now nobody will be interested in buying our Residential Mortgage Backed Securities, the market will know the true value of the loans currently being held by banks all over the U.S., mortgage lending slows way down, interest rates go way up, and the housing market goes cliff diving.
It seems to me that with this first bailout proposal (I am preparing for more bailouts as should you) everything is just going to be delayed as long as possible, taking us down further into a deeper recession step-by-step.
This bailout proposal is not enough. We have only just begun to see foreclosures rise. We still have the rest of 2008 to get through, when another round of pay option ARMS originated in 2006 begins to adjust, and through 2009 when the ARMs originated in 2007 adjust. Defaults and foreclosures are far from over.
There was a guy who predicted the demise of Fannie and Freddie back in 2006. His proposal is that we nationalize Fannie and Freddie, quit pretending that they’re a private company, and restructure the debt, thereby forcing the bondholders to take a haircut.
Sniglet asks an interesting question (comment 123): “So what happens to the shareholders? Do any of these plans ensure that there is no dilution of equity if any form of bail-out were to occur? If the GSE shareholders aren’t protected then we could see a complete abandonment of the financial system by investors. Who will want to buy shares in financial firms if the government isn’t going to ensure their investments remain safe?”
From everything I’ve read over the weekend, the government likely will not protect shareholder equity. Whether or not they should is up for debate.