A 'Failed Business Model'
Opinion: Steve Forbes: What Next For Fannie & Freddie? A 'Failed Business Model' Washington: Outsiders' Insight May Be Right Thing For GSEs Fannie And Freddie's 15-Month Fix Dodd On The Bailout The Road From Here Wall Street: BofA's Bailout Benefit Some Banks Get Burned The Bailout Boon For Euro Banks Video: Beyond The Bailout Fannie, Freddie And The Taxpayer Banks After GSE Bailout
Henry Paulson's plan is a major disappointment.
Although it was certainly necessary to bail out ailing mortgage giants Fannie Mae (nyse: FNM - news - people ) and Freddie Mac (nyse: FRE - news - people ), the plan put forward by the treasury secretary this weekend prioritizes steering them back to financial health and defers into the future what is to become of the companies.
What's worse, after blaming the collapse of the companies on a "flawed business model," the plan will preserve that model indefinitely, allowing the shareholders of what are now insolvent entities to recover some value.
Long after Paulson is gone from the Treasury, Washington will be wrestling with the problem of what to do about Fannie and Freddie. And if the two companies are eventually nationalized, privatized or liquidated, the government--meaning taxpayers--will have to compensate the existing shareholders in some way.
The plan is relatively simple, but its implications for the future are troubling. First, Fannie and Freddie will be put under government control in an arrangement called a conservatorship. The purpose of a conservatorship is, essentially, to keep things as they are.
A conservator does not have the power to make any significant changes to the business model of a company; rather, its focus is to guide the company back to stability. Why anyone would sustain what Paulson himself called a flawed business model is hard to understand.
It gets worse. Under the plan, the Treasury is committed to providing equity capital to Fannie and Freddie. Another puzzle: Why is it necessary to inject taxpayer funds into these companies as equity? Ordinary companies need capital so that they can meet their obligations, but both these companies will have access to a financial facility at the Treasury that will allow them to borrow all the funds they require.
They don't need capital. The injection of capital is, in fact, a gift to the existing shareholders, who--as the owners of insolvent companies--own nothing and deserve no benefits from the taxpayers. By injecting these taxpayer funds and enabling the companies to survive, the Treasury plan opens the possibility that the existing shareholders will eventually profit from their investments, when, by all rights, they should be wiped out.
The nature of this gift is further emphasized by the fact that the Treasury is taking warrants for its agreement to finance these companies. These warrants will only be worth something--and thereby allow the Treasury to compensate the taxpayers--if the companies are nursed back to financial health under the conservatorship. So the government has created an incentive for itself to keep the companies alive and restore their well-being.
Once that occurs, the current shareholders will again be able to reap the benefits of holding interests in government-sponsored enterprises (GSEs)--only in this case, the two companies will not be implicitly backed by the government; they will be explicitly backed. In that case, the shareholders and the managements will once more profit from the government backing, while the taxpayers will still be the ones taking the losses.
There was an alternative, one that was simpler and much more sensible from a policy perspective. Since Fannie and Freddie operated under this "flawed business model"--by which Paulson probably meant government backing for shareholder-owned companies, the essence of a GSE--the plan should have set things in motion for the elimination of this model.
Instead of a conservatorship, the plan should have provided for a receivership. That system would get rid of the common stockholders while still monitoring the companies for an indefinite period in order to keep the mortgage market functioning smoothly.
Thus, while Paulson's plan was intended to provide some "breathing room" for consideration of the companies' future, what it will do in effect is restore them to health as government-sponsored enterprises, and, more critically, allow them and their newly empowered shareholders to bargain about the companies' collective future from a position of strength.
No wonder U.S. Sen. Charles Schumer of New York--probably the GSEs' most ardent supporter in Congress--issued the following statement after Paulson addressed the press on Sunday: "This plan will be met with broad acceptance in Congress, because it doesn't prejudge the ultimate fate of Fannie Mae and Freddie Mac.'' Translation: Prepare for a fight--because we intend to keep the GSEs alive.
Republican presidential candidate John McCain has been campaigning against the culture of corruption in the federal government. Democratic presidential candidate Barack Obama has based his campaign on the idea of change in Washington. Fannie Mae and Freddie Mac are telling illustrations of corporate welfare--the profitable private exploitation of a cozy relationship with the government. And the Paulson plan will foster just what a cynic might expect: more of the same.
Peter J. Wallison is the Arthur F. Burns fellow in financial policy studies at the American Enterprise Institute . General counsel of the Treasury during the Reagan administration, he is the author of Ronald Reagan: The Power of Conviction and the Success of His Presidency and Serving Two Masters, Yet Out of Control: Fannie Mae and Freddie Mac.
The Trouble With Fannie, Freddie
Freddie, Fannie Bailout
http://www.forbes.com/opinions/2008/09/08/...tml?partner=rcm
Reflections from news and commentary of the day
Subscribe To
Posts
Comments
6 comments:
Fannie and Freddie's New Derivatives Cliffhanger
The bailout triggers settlement of $1.4 trillion in unregulated credit-default swaps. Do the hedge funds have the money?
http://www.businessweek.com/bwdaily/dnflas...ws+%2B+analysis
Bailing Out Right-Wing Economics
Last weekend, the Bush administration took the necessary step of bailing out Fannie Mae and Freddie Mac, the two congressionally chartered, but privately held, troubled mortgage giants whose missions include "boosting homeownership and funding apartment construction for low- and moderate-income families." The two firms "guarantee or own roughly half of all the $12 trillion US mortgage market" and, as such, their bailout "represented one of the most sweeping interventions in financial markets since the Depression," according to the Wall Street Journal. Under the Bush administration plan, the two companies have been placed "under 'conservatorship,' a legal status akin to Chapter 11 bankruptcy" and the government "replaced the companies' chief executives and shifted management control to their regulator, the Federal Housing Finance Agency." The two firms recently suffered billions in losses due to the unprecedented number of defaults and foreclosures in the U.S. housing market. Earlier this summer, the U.S. Treasury began to fear the firms' liabilities were in danger of exceeding their assets and asked Congress to allow a federal bailout, should the need arise. The bailout is reminiscent of the Bush administration's $30 billion rescue of Bear Stearns in March, a move that President Bush and his conservative allies called "the right decision." Dispensing with regulatory oversight, only to embrace dramatic and expensive subsequent bailouts, has become the hallmark of years of failed right-wing stewardship over the economy.
'PRIMARY CONTRIBUTORS': In an op-ed in yesterday's Wall Street Journal, Sen. John McCain (R-AZ) and Gov. Sarah Palin (R-AK) reluctantly endorsed the federal takeover of Fannie Mae and Freddie Mac, arguing that the two institutions' lobbyists are the "primary contributors to this great debacle." McCain and Palin wrote that, should they be elected, their administration would "no longer use taxpayer backing to serve lobbyists, management, boards and shareholders." Fannie Mae and Freddie Mac "spent a combined $170 million" over the past 10 years on lobbying activities aimed at creating "a sort of regulation-free zone around their businesses." Although McCain and Palin are correct in naming lobbyists as "primary contributors" to the current crisis, their feigned outrage rings hollow because "at least 20 McCain fundraisers have lobbied on behalf of Fannie Mae and Freddie Mac" in recent years. In all, these 20 fundraisers earned "at least $12.3 million in fees" from the two institutions. More troubling, however, is the fact McCain's campaign manager, Rick Davis, "served as president of an advocacy group led by Fannie Mae and Freddie Mac" that worked to cripple regulatory initiatives in Congress. Fannie Mae and Freddie Mac founded the lobbying organization because they feared that "congressional meddling would lower their healthy profits." During his tenure, Davis moved to challenge even the smallest measures to make sure that Fannie Mae and Freddie Mac are be held more accountable for their actions. In July 2003, for example, Davis "wrote to the American Banker, taking issue with an opinion piece...arguing that Fannie and Freddie should operate with greater transparency." Such transparency and greater regulatory controls could have helped avert the current crisis.
MORE THAN SIZE: The Bush administration argued that the interventions were needed not because federal regulators had been "asleep at the switch" as Fannie Mae and Freddie Mac deepened their involvement in the subprime lending market, but because Congress failed to act as the two institutions grew "too big to fail." The remedy, the Bush administration suggests, is simply downsizing their held portfolios at a rate of 10 percent per year, presumably until the two firms are no longer "too big to fail." But as Center for American Progress Senior Fellow David Abromowitz explains, the problem is that "the intertwined nature of global financial markets today requires" federal intervention "even in the case of smaller financial players...when regulators fail to do their jobs." Abromowitz asks, "How small would [Fannie Mae and Freddie Mac] have to get to matter little if they failed but still be able to benefit consumers?" U.S Treasury Secretary Henry Paulson believes such questions are beside the point, arguing on Monday that the two institutions "should not have existed" at all. Similarly, Alan Greenspan has argued that the two firms "should be broken up, made smaller and fully privatized, without even a whiff of government support." Such statements however, ignore the very real benefits that Fannie Mae and Freddie Mac deliver: keeping "the supply of money widely available and at a lower cost" and ultimately expanding access to homeownership. As Abromowitz writes, "If one concludes that the current housing crisis results heavily from laissez-faire ideology trumping common sense protection of safety, soundness, and consumers, then the logical remedy would be to require more effective regulation" -- not piecemeal privatization.
MORE OF THE SAME: McCain's endorsement of the bailout of Fannie Mae and Freddie Mac is the second major federal intervention that he has supported in recent months. In March, he backed the Federal Reserve's decision to extend a $30 billion credit line to finance the takeover of Bear Stearns by JP Morgan. The strange dissonance between McCain's free-market, pro-deregulation rhetoric and his repeated support for sweeping government interventions suggests that a McCain administration would depart little from the Bush administration's status quo. One example of just how close McCain and Bush are to one another with regard to financial policy is the Bush administration's appointment of Herbert Allison to head Fannie Mae in the wake of the government bailout. Allison is a close McCain ally who during McCain's 2000 campaign was considered the "best bet" to become McCain's Treasury Secretary. McCain himself argued yesterday that the U.S. Treasury "had broadly followed the McCain plan" for the Fannie Mae and Freddie Mac bailout. McCain and Palin lament that "Fannie and Freddie's lobbyists succeeded and Congress failed" and claim that "under our administration this will not happen again." However, their pattern of endorsing dramatic and expensive federal bailouts, while shunning the regulatory measures needed to prevent them, suggests otherwise.
Nationalization of Fannie, Freddie triggers defaults for derivatives
Submitted by cpowell on 05:03PM ET Monday, September 8, 2008. Section: Daily Dispatches By Aline van Duyn
Financial Times, London
Monday, September 8, 2008
http://www.ft.com/cms/s/0/ed1e14c6-7dd0-11...658.html?ncli...
One of the largest defaults in the history of the $62,000 billion credit derivatives market has been triggered by the US government's seizure of Fannie Mae and Freddie Mac, raising questions about how dealers will unwind billions of dollars worth of contracts.
Although the $1,600 billion of debt issued by the troubled mortgage groups is regarded as safe after the US government's move to take control of the companies, their move into "conservatorship" counts as the equivalent of a bankruptcy in the credit derivatives market.
This triggers a default on credit default swaps -- instruments that provide a form of insurance on fixed-income assets. Dealers in the market are now working to settle these contracts.
The exact amount of CDS on Fannie Mae and Freddie Mac are not known, reflecting the private nature of the market, but they are part of widely traded indices and the amounts are likely to be significant. Analysts at Lehman Brothers said: "There is likely to be a considerable amount of notional protection outstanding."
The industry body, International Swaps and Derivatives Association, said on Monday it would launch a protocol to facilitate settlement of credit derivative trades involving Fannie Mae and Freddie Mac and would publish further details in due course.
The uncertainty surrounding the Fannie Mae and Freddie Mac CDS contacts highlights the need for improved settlement and trading procedures. Already, regulators have put pressure on CDS dealers, including all the large financial institutions, to reduce settlement and trading risks.
The near-collapse of Bear Stearns in March highlighted the extent to which many large financial institutions were linked together through the CDS market, and the Federal Reserve and other regulators want to reduce such systemic financial risks.
The growth of the CDS market over the past decade has outpaced development of settlement systems and trading infrastructure. One worry is the lack of standard procedures in contracts for dealers to agree ways to settle defaulted credit derivatives.
The actual payments on credit default swaps on Fannie Mae and Freddie Mac are expected to be limited because the value of the mortgage agencies' debt remains high after the US government stepped in to back it.
That means that meeting any claims on CDS may not be that costly, although the details are still being worked out and the impact is unknown.
Analysts at Creditsights said regulators could "use the bailout as another lever" to enhance the CDS market's efficiency.
"Where's the damn outrage? -- The two CEOs who were relieved of their duties at Fannie and Freddie, as I understand it, received parting gifts of $9 million and $14 million. Disgusting! And what about the CEO's of all the big banks and the 219 local banks on the "watch list." They allowed their banks to buy so many toxic bonds that when the bonds were priced to market, the banks were seen to be under water. What happens to all these moron CEOs? Do they get kicked out with gifts of millions too? Where's the responsibility? Where's the justice? Where's the outrage? Why aren't charges brought against these fakers who got away with super-stupidity and derelictions of duty? Why are they receiving millions as they are kicked out of office? Disgusting, shameful, ugly! And there's no outrage."
Richard Russell, Dow Theory Letters
Silence of Lambs
William Greider: The bailout of two mortgage giants sticks the American taxpayer with the bill--with not of peep of protest from Obama and McCain.
http://www.thenation.com/blogs/notion/356921
Freddie/Fannie: What Did It Take to Get Management/Board Onside?
PrintShare
Delicious Digg Facebook reddit Technorati
Paul Kedrosky | Sep 10, 2008
Why didn't the Freddie/Fannie bailout deal wipe out the common shares? That's one question most people have, myself included, as we look at the structure of the deal. Leaving common shareholders with 20% of the equity of the firms seems unnecessarily generous. Is that price that was required to get management on board during the transition to conservatorship? Was it the carrot?
Because it seems clear what the management stick was alongside the hypothesized carrot. That was the silly story planted in the media yesterday that Freddie/Fannie played games timing their liabilities, and so their balance sheets were squishier than regulators thought.
Gosh, you think? Did anyone really think that Freddie and Fannie played it straight up? There had only been a host of analysis suggesting same for some time -- I even prattled about it on CNBC weeks ago. Leaking that information to the media now strikes me as a stick trying to get cooperation out of the two companies' respective CEOs. You know, "Play along, or we'll make you look like bad men for diddling the numbers."
But was the other side of the deal not washing out the common shares? Granted, it's not a huge carrot, but it is a carrot to avoid management/board lawsuits -- notice how careful Paulson was to say that this was not management's or the board's fault -- and even provide some wildly unlikely upside.
Originally published at Infectious Greed and reproduced here with the author's permission.
* Related RGE Content:
* Reactions To GSE Bail-Out: Is This The Best Deal For Taxpayers? For the Financial System?
* GSEs Not Nationalized But in 'Conservatorship', Bail-Out for Creditors, Shareholders Trimmed But Not Wiped Out
* Overview of Long-Term Solutions for Government-Sponsored Enterprises (GSEs)
http://www.rgemonitor.com/us-monitor/253527/freddiefannie_what_did_it_take_to_get_managementboard_onside
Post a Comment