Monday, September 8, 2008

Fannie Mae And Freddie Mac Seized

Probably the biggest news this weekend--alongside Tom Brady’s injury, if you are a football fan--was the report that the U.S. government is seizing control of Fannie Mae and Freddie Mac. There has been a lot of talk about this possibility over the past couple months, but I think the move was still a little shocking to most people. When we think of the U.S., we think free markets, and the seizure of companies definitely goes against that principle. While this might have come as a surprise to some, considering the bind we put ourselves in, this was the right move.

Typically I would be the last one to support the seizure of a company, but in this instance things are a little different. Obviously, the biggest difference is that in the case of Fannie and Freddie, taxpayers are potentially on the hook for trillions of dollars, with or without a government seizure. With this in mind, we needed to better align the goals of the company with the goals of the taxpayers. Since the taxpayers had little to gain from company profits, their only goal was that the companies don’t cost them any money. For too long, these companies had been profiting from an implicit guarantee from the government, allowing them to take on excessive risk.

How the current deal is set up with the companies is that the government has been issued preferred shares that are senior to all existing shares. This means that, in the event of liquidation, the government gets paid first. In addition, these shares pay out a 10 percent dividend yield, while at the same time the government cut the dividends for most other shareholders. This initial move did not require an injection of capital from the government, but the government has pledged to provide as much as $200 billion to the companies, according to the Wall Street Journal. The government also has acquired warrants which would allow then to acquire 79.9 percent of the companies for a nominal sum, according to the Wall Street Journal. Obviously, if the government were to exercise their warrants, the remaining shares would be so diluted that they practically worthless. The government has also ousted the companies’ leadership and placed the responsibility on the companies’ regulatory commission, the Federal Housing Finance Agency.

While my personal preference would have been to not offer the implied guarantee, followed by the actual guarantee in the first place, given our current circumstances, this move was in the best interest of taxpayers. Sure, it is going to cost us several billion dollars when all is said and done; whatever the number ends up being, though, it is likely to be less than we would have paid if we didn’t take over the company. At least in this scenario the government has some potential reward rather than only shouldered risk. The government hasn’t really put together a plan for how to deal with these companies over the long term, but I’d imagine it would involve some serious restructuring, which is definitely a good thing. Stay tuned for more information as things develop.

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1 comments:

September 8, 2008 at 6:16 PM Anonymous said...

It seems to me that the government is holding the warrants over the heads of Fannie and Freddie in order to give them extra encouragement to bring the companies back to profitability. I don't see the government taking over the companies unless they begin pouring billions into them, which is doubtful now that agency debt should get the borrowing rate as the treasury. As soon as the 30yr mortgage rate drops, we should start seeing some recovery in housing.

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