Excerpts from the Press Release about the Death of Fannie and Freddie…..

Treasury Press Release

I have clearly stated three critical objectives: providing stability to financial markets, supporting the availability of mortgage finance, and protecting taxpayers – both by minimizing the near term costs to the taxpayer and by setting policymakers on a course to resolve the systemic risk created by the inherent conflict in the GSE structure.

What he’s talking about in terms of the inherent conflict is that Fannie and Freddie are essentially government institutions with shareholders and that creates a conflict of who do they serve – the shareholders or the common good?

I attribute the need for today’s action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither. New CEOs supported by new non-executive Chairmen have taken over management of the enterprises, and we hope and expect that the vast majority of key professionals will remain in their jobs.

Out with the old, in with the new – and we hope that the main people besides for upper management don’t leave.

First, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth.

That means that if Fannie or Freddie has a bad quarter and loses enough so that they become upside down, we get to turn on the faucet and fill them up with more cash.   Your cash and mine.

It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set.

On an as needed basis – as often as needed and on terms the Treasury has set (only when they go negative).

Market discipline is best served when shareholders bear both the risk and the reward of their investment. While conservatorship does not eliminate the common stock, it does place common shareholders last in terms of claims on the assets of the enterprise.

If you hold common stock in Fannie or Freddie, you are the first one to get hit with the losses.

Similarly, conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses. The federal banking agencies are 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 GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital.

If you hold preferred stock, you are second in line to get hit with the losses.   Oh, and we know that a lot of  banks own preferred stock in Fannie and Freddie and that’s not going to be healthy for their books.   But it’s only going to sink a couple of banks, so that’s a worthwhile risk.    Tell that to those banks!

The second step 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 need cash in order to keep on writing loans.   Lots and lots of cash.

Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS.

That means that they are going to pick up the slack, I mean we, are going to pick up the slack and start buying the loans that Fannie and Freddie are packaging and selling.

And let me make clear what today’s actions mean for Americans and their families. Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today.

The consequences of allowing Fannie and Freddie to go under were simply too big and too disastrous to make that possible.   Think Nightmare on Elm Street, Doomsday scenario for the financial markets……

Because the GSEs are Congressionally-chartered, only Congress can address the inherent conflict of attempting to serve both shareholders and a public mission. The new Congress and the next Administration must decide what role government in general, and these entities in particular, should play in the housing market. There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes.

The discussion needs to take place on what are Fannie and Freddie going to look like down the road.   The future of mortgage lending will end up looking much different than it does now.

I’ll have more as I have the chance.

Tom Vanderwell