The Back Alley Archives

I am still working my way through the details of the GSE takeover by Treasury, but here is my initial read of the details:

• FHFA will act as conservator of the two firms -- meaning the US government has day-to-day control of Fannie and Freddie;

• The conservator's goals are to (1) put the company in a sound and solvent condition, and (2) carry on the company's business and preserve and conserve the assets and property of the company.

• There is an immediate moratorium of the firms' lobbying activities.

• New lending facility: "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;"


• Fannie and Freddie will increase their mortgage-backed securities portfolios through the end of 2009. (Treasury is initiating a temporary program to purchase GSE MBS).


• Treasury purchases the mortgage-backed securities from the firms; no word about any derivatives or swaps owned by the two;

• Starting in 2010, the portfolios must be reduced at the rate of 10% per year.

• Both CEOs (Daniel Mudd and Richard Syron) dpart after a transition period. TIAA-CREF Chairman Herb Allison will take over as CEO of Fannie; U.S. Bancorp Chief Executive David Moffett at Freddie.

• Senior preferred stock purchase agreement includes an upfront $2 billion issuance of senior preferred stock with a 10% coupon ($1B per GSE); Dividends are quarterly starting in 2010, and warrants represent an ownership stake of 79.9% in each firm.

• 3 Goals of the takeover: market stability, mortgage availability and taxpayer protection.


• The takeover is the result of a "detailed and thorough collaboration between FHFA, the U.S. Treasury, and the Federal Reserve;"

This looks like a 80% haircut for the common holders, I am trying to figure out if this is a haircut for the preferred holders . . .


UPDATE: It seems the Preferred Shareholders take an even bigger haircut than the common, as they lose the present dividend payments.

Sept. 7 (Bloomberg) -- The U.S. government seized control of Fannie Mae and Freddie Mac after the biggest surge in mortgage defaults in at least three decades threatened to topple the companies making up almost half the U.S. home-loan market.

``Our economy and our markets will not recover until the bulk of this housing correction is behind us,'' Treasury Secretary Henry Paulson, who engineered the takeover along with Federal Housing Finance Agency Director James Lockhart, said in Washington today. ``Fannie Mae and Freddie Mac are critical to turning the corner.''

The FHFA will take over Fannie and Freddie under a so- called conservatorship, replacing their chief executives and eliminating their dividends. The Treasury can purchase up to $100 billion of a special class of stock in each company as needed to maintain a positive net worth. It will also provide secured short-term funding to Fannie, Freddie and 12 federal home-loan banks, and purchase mortgage-backed debt in the open market.

The takeovers bring Fannie, formed after the Great Depression and spun off in 1968, and Freddie, created in 1970, back under the government's fold. It's the biggest step yet in officials' efforts to grapple with a yearlong credit crisis that has caused more than $500 billion of losses and writedowns.

Treasury Gets Stock

Under the plan, the Treasury will receive $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie and Freddie. The government will receive annual interest of 10 percent on its stake.

As a condition for the assistance, Fannie and Freddie eventually will have to reduce their holdings of mortgages and securities backed by home loans.

The portfolios ``shall not exceed $850 billion as of Dec. 31, 2009, and shall decline by 10 percent per year until it reaches $250 billion,'' the Treasury said. Fannie's portfolio was $758 billion at the end of July, and Freddie's was $798 billion.

Officials are aiming ``to prevent the mortgage market from falling apart,'' said former Federal Reserve Bank of St. Louis President William Poole. The Treasury's funds ``will be flowing in for quite a long time,'' Poole, a Bloomberg contributor, said on Bloomberg Radio.

The federal banking agencies have been assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac. The agencies believe that, while many institutions hold common or preferred shares of these two government-sponsored enterprises, a limited number of smaller institutions have holdings that are significant compared to their capital.

The Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision are prepared to work with these institutions to develop capital-restoration plans pursuant to the capital regulations and the prompt corrective action provisions of the Federal Deposit Insurance Corporation Improvement Act.

All institutions are reminded that investments in preferred stock and common stock with readily determinable fair value should be reported as available-for-sale equity security holdings, and that any net unrealized losses on these securities are deducted from regulatory capital.

Hank Paulson’s effort to prop up Fannie Mae and Freddie Mac has various beneficiaries but few gain more than foreign investors.

One effect of the way the quasi-nationalisation is structured is that US institutions may well suffer more than foreign ones. In brief, it is good for overseas central banks and sovereign wealth funds but bad for US regional banks.

The exuberance in non-US markets this morning is a reflection of that fact. The government has had to step in to reassure foreign investors who have become huge buyers of agency debt, but has treated US equity holders harshly.

As Saskia Scholtes and Krishna Guha point out in the FT this morning, US regional banks could well pay the highest price:

Fannie and Freddie’s combined $36bn of preferred stock is widely held by US regional banks. These banks will be forced to take significant write-downs of their holdings.

Few banks have provided detailed disclosures on the extent of their holdings in Fannie Mae and Freddie Mac, but among those that could be most affected are Gateway Financial Holdings and Midwest Banc Holdings. According to recent research by analysts at Keefe, Bruyette & Woods, both banks have exposure that amounts to more than 30 per cent of their tangible capital.

Meanwhile, foreign holders of agency debt including that issued by Fannie and Freddie have been given a cushion. The US government has not given full sovereign backing to senior and subordinated debt but it has provided comfort.

This is very significant for all the foreign investors, including foreign governments and wealth funds that have piled into agency debt over the past 15 years, regarding it as a substitute for US Treasuries.

They did not come up with this on their own. Fannie and Freddie travelled the world to persuade foreign investors that their debt was a good bet. It turns out that they were correct, at least about that.

According to recent Treasury figures, foreign holdings of US agency debt rose from $107bn in 1994 to $1,304bn in June last year. This outstripped the rate of growth of foreign holdings of both US Treasuries and corporate debt.

Recently, however, foreign investors had begun to get cold feet about agency debt. The FT reported last month, for example, that Bank of China had cut its exposure to agency debt over the summer.

Mr Paulson thus found himself with a fait accompli. The federal government had to give reassurance to foreign investors in agency debt if it wanted to avoid chaos in financial markets and a run on the dollar.

It smacks of debt crises past in Latin American countries, where the ultimate pressure for a bail-out came from foreign investors.