WSJ Reporting Deal Near to put Fannie and Freddie into Conservatorship

The Wall Street Journal is reporting tonight that the time is almost up for Fannie and Freddie. That didn’t take long. No wonder the bill was rushed to President Bush to be signed at the end of July.

The plan is expected to involve putting the two companies into the conservatorship of their regulator, the Federal Housing Finance Agency, said several people familiar with the matter. That would mean the government would take the reins of the companies, at least temporarily.

Plans include the government gradually injecting capital into the two companies and a “top level management shakeup.”

Freddie and Fannie own or guarantee more than $5 trillion of mortgages. They have suffered combined losses of about $14 billion over the past four quarters as they make provisions for a wave of defaults. Investors worried that a government bailout would wipe out the value of existing stock, and those fears have sent the shares down about 90% from a year ago. Many U.S. banks as well as foreign governments own stock or debt in the two giants, meaning their financial woes could cause broad problems beyond the housing market.

Emphasis mine.

This breaking story has already been updated. Read more here at the Washington Post and NYTimes.

Fannie Mae and Freddie Mac to be put under control, sources say

U.S. rescue seen at hand for mortgage giants


Here’s Bloomberg; Paulson plans to bring Fannie, Freddie under government control

Reuters: Fannie Freddie shares fall after report of bailout

I’m sure there will be more stories posted all throughout the weekend.  This Fannie and Freddie takeover is something I could have never imagined when I started my career in mortgage lending 25 years ago.  When they raised the conforming loan limit several months ago and allowed F&F take on Jumbos, there were many who said F&F wouldn’t be able to survive if loan defaults continued to rise.  Firstam Core Logic says defaults will to continue to rise for at least the next 18 months.  We should now begin thinking about the FHA mortgage insurance program and their 3.5% down requirement.  That equity goes away fast during a down market.

I am heading out to the Edmonds Woodway High School Football game. I will post a link to that CoreLogic report and any updates when I return.  Link to CoreLogic PDF posted above. 

Update 2: Sunday morning press release from Paulson:

Statement by Secretary Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers

Washington, DC–

Good morning. I’m joined here by Jim Lockhart, Director of the new independent regulator, the Federal Housing Finance Agency, FHFA. In July, Congress granted the Treasury, the Federal Reserve and FHFA new authorities with respect to the GSEs, Fannie Mae and Freddie Mac. Since that time, we have closely monitored financial market and business conditions and have analyzed in great detail the current financial condition of the GSEs – including the ability of the GSEs to weather a variety of market conditions going forward. As a result of this work, we have determined that it is necessary to take action.
Continue reading here.


Readers, what effect do you believe a F&F conservatorship will have on the local and national real estate market?

50 thoughts on “WSJ Reporting Deal Near to put Fannie and Freddie into Conservatorship

  1. The BIG question is what will happen to the shareholders? Will existing shareholder equity be wiped out? If so, there could be significant ramifications to the financial health of many other insitutions since GSE shares are so widely held.

    I can’t imagine that any kind of default would be allowed on GSE debt, so the holders of these securities likely have little to worry about.

    Lastly, the other thing that we will have to see is whether this conservatorship will lead to a further tightening of mortgage credit. Will the new GSE managers be as willing to buy Jumbos and prop up the real-estate market as the existing ones?

  2. Kary said: “I’m not sure what the legal basis for doing this would be.”

    The GSEs are heavily governed by legisliation already, so it isn’t all that much of a stretch for the government to do an outright take-over. Congress already passes laws telling the GSEs what the conforming limits are, and how much they can/should contract their businesses. Heck, there are even laws mandating the GSEs take on the job of working with minorities and expanding home-ownership.

    In short, these were never really private firms to begin with.

  3. Sniglet, the plan for shareholders is all over the map with much speculation. I’m expecting there to be a weekend meeting with the plan announced late on Sunday, before the Asian markets open, similar to the Bear Stearns/JPMorgan Chase bailout.

  4. Sniglet, re #3 I realize that, but it’s an entirely different matter to affect third parties directly–e.g. shareholders.

    What I don’t understand about this is timing. I thought one of the two was better capitalized than the other, so why both? And last I read, neither had tapped the Fed resources yet. Finally, although the plan has not been announced, it’s not clear what this actually does to help things, unless they saw major problems with the leadership of both entities. I don’t see how this will help either entity borrow more money or otherwise function. So what does this do over the government just loaning them the money?

    Q-diddy–I’m not sure you can say either at this point, but probably at least the latter part is right. But I wouldn’t even bet on that.

  5. Kary wrote: “I thought one of the two was better capitalized than the other, so why both? And last I read, neither had tapped the Fed resources yet.”

    The reality is that BOTH Fannie and Freddie were vastly under-capitalized considering the amount of losses they are seeing. Sure, one GSE might have a few billion more in capital, but when the assets they hold are in the trillions that doesn’t really amount to much.

    I think things were VERY serious behind the scenes, which is what prompted the government to act. Once the GSEs had lost the ability to raise fresh capital themselves (i.e. with the collapse of their stock prices), it was really only a matter of time before the government had to take over. Borrowing money from the Fed wouldn’t help. When you need to raise capital to cover losses, BORROWING money (which is what they would be doing by tapping the Fed) is now answer since it shows up as a liability on your books. Moreover, the GSEs never did lose access to the credit markets (unlike some other banks like CitiGroup that find they can’t issue any bonds for anything under 10% yields), so it’s not like they had problems borrowing money on their own.

  6. I meant short term–operating capital.

    I’m interested in your last comment about borrowing short term. Isn’t that how they always operated? Rather obviously at this point they couldn’t sell stock, but I don’t see how this would help with that.

  7. Kary said: “I’m interested in your last comment about borrowing short term”

    The problem is that the GSEs need to maintain a certain ratio of cash to assets and liabilities. If the value of their assets declines they need to raise more cash. Just selling more bonds won’t cut it since the bonds also create liabilities on their books. When the value of a lender’s assets declines they MUST raise more capital. The only way to do that is through issuing shares.

    In effect, this is what is happening with the GSEs. Just think of the US government as a private investor who is giving a massive capital infusion to the GSEs in exchange for a huge equity stake (i.e. which wipes out all other stock holders).

  8. Kary –

    What really happened is that the foreign central banks who had bought most of the F/F paper in the last month started selling it and not buying more for the first time ever. They bought Treasuries instead, basically telling the companies that if they wanted any more money they were going to have to be explicitly guaranteed by the government. I am sure this is really why the takeover now, the people floating those mortgages didn’t want to live with only a “maybe” anymore.

  9. Kary wrote: “Wouldn’t a simpler solution be to have the US Government explicitly guarantee the new debt?”

    No. As I said before, the GSEs need to raise fresh CAPITAL (i.e. cash reserves that have do not have to be repaid). A guarantee of GSE debt doesn’t help one bit in the effort to raise new capital.

    Since the GSEs can’t issue stock to get capital the only other option is a cash infusion from the government.

    Keep in mind that the core issue here is that the value of the mortgages the GSEs have in their portfolio continues to drop, which then necessitates the raising of more capital (i.e. to keep the capital to asset reserve ratios in balance). Now, if someone could somehow cause house prices to begin appreciating or foreclosure rates to slow then the GSEs wouldn’t be in the predicament of having to keep raising fresh capital.

  10. Sniglet, I was actually referring to “b’s” post, where he indicated that they were having problems selling the bonds. I’d agree if capitalization is the problem, it wouldn’t help, but if it’s more short term cash flow type issues, it would.

  11. Kary wrote: “they were having problems selling the bonds”

    Not really. The GSEs haven’t had a failed bond sale yet. Investors have actually been eager to buy GSE bonds precisely because they are guaranteed by the government.

  12. Great comment from “Da Man” on this comment thread over at CR:

    ” “Without them the housing market is toast.”

    I think it goes a little deeper than that. The GSE bonds became a dumping ground for foreign investors to park their dollars. Instead of buying treasuries, they seem to have been guided into buying the GSE’s at a higher yield. The higher yield was supposed to be for the extra risk since they were not officially backed by the government.

    So it’s sort of about housing, but also supporting the dollar. Otherwise the foreign investors will start bailing out too fast. That’s similar to what we saw since June with them pulling out of GSE bonds and into Treasuries.

    The scam to the taxpayer is that these investors received the higher yield for the risk taking the GSE over treasuries all this time. Now, it comes time to pay for the risk. And it’s not the bondholder who has to pay that enjoyed the higher yield, but the taxpayer.

    So in short, I think alot of it goes back to keeping foreign investors happy so they don’t start dumping their dollars and collapse our economy faster than we’d like.”

  13. Kary –

    What do you think this solution is? The government is taking over the companies and granting an explicit guarantee. They are engineering it to push money in quarterly to spread out the pain, but everyone knows what the result is. The foreign investors started to say “no thanks” and obviously behind the scenes made it clear this was not a temporary blip. Sniglet is right that they haven’t failed a selling yet, but if the central banks say no they will start failing them which would be much more catastrophic for equity and other markets than this takeover. They had some enormous amount of bond selling coming up for their cycle in the next two quarters if I recall correctly, so the Treasury/Fed was probably very concerned the Chinese and Russians just weren’t going to show up.

  14. I wonder if the government is seizing the GSEs in part to increase their lending and goose the real-estate market. With explicit government backing GSE mortgage rates should come down (i.e. bonds will have lower yields). Further, with the treasury providing tens of billions in additional capital it will be easy for the GSE to increase their portfolios even more.

  15. b, I just think it might be overkill, and a lot of unnecessary bureaucracy. Is there a problem with the management that can’t be dealt with by regulation? Are they doing something wrong now such that management needs to be taken out?

    Loan them the money, guarantee the new debt, change the require ratios, etc. I just don’t see what the conservatorship does for anyone, absent the type of existing problems mentioned in the first paragraph.

    BTW, I think Jillayne made reference to this, but I’m losing a bit of confidence in Washington knowing what to do when they just recently increased the conforming loan limits. This makes that seem like perhaps not the best decision, which calls into question the decision making process.

  16. Sniglet, I was thinking something similar, but different. I was wondering if it was to reduce pressure off of FHA. One of those articles mentioned F&F doing about 70% of the loans. I doubt that’s been true for the past 2 months. Lowering the rates would get people moving back to F&F loans.

  17. Pingback: Fannie / Freddie Takeover | Seattle Bubble — News & discussion about real estate & the housing bubble in the Seattle area.

  18. Sniglet,

    Looks like you are correct. The GSE’s are going to increase their exposure to MBS throughout 2009 and then start cutting back 10% per year in 2010.

    Looks like the pigmen can thank the taxpayers once again for another gigantic transfer of wealth. Oh well, J6P won’t care, football season is here. Pop open another Busch Light and watch the game!

  19. It will be interesting to see if yields on the 10 yr shoot to the moon on Monday. GSE rates may come down, but if the 10 yr yield spikes up it could be a moot point.

    Contaminating T notes with MBS cannot be a good idea.

  20. For anyone who’s interested, I wrote up my thoughts on the GSE conservatorship here.

    quote: “The up-shot of all of this is that the last of the building blocks have now fallen into place that makes the US government both the first and last resort of mortgage finance. Already something like 90% of all US mortgages have been made through either Fannie, Freddie, or FHA in the last few months. Now that the government is going to be making outright purchases of mortgage securities it won’t be long before the US government provides over 99% of mortgage finance. With the US treasury willing to buy mortgage securities for less than rates that private investors would be willing to, then how could there possibly be any space for private finance?”

    “Ironically, the GSE conservatorship (and the decision to EXPAND the GSE portfolios) will almost inevitably destroy the rest of the private banking system, and FORCE even more conservatorships. No private institutions can possibly be profitable now that they have to compete with subsidized government lenders.”

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