In this rescue, some are bailed -- and some are nailed
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Is it a bailout, or isn’t it?
With the Treasury committing up to $200 billion of taxpayers’ money for direct investment in Fannie Mae and Freddie Mac -- and billions more for loans to the companies and purchases of their mortgage-backed bonds -- surely somebody is getting bailed out in this rescue package.
But the immediate beneficiaries aren’t the companies’ common shareholders, nor the investors in Fannie and Freddie preferred shares. They could very well lose everything.
Think more along the lines of the Chinese central bank, Persian Gulf sovereign wealth funds, state government investment funds and other investors that own either the company’s corporate bonds or their trillions of dollars in mortgage-backed bonds, or both.
And, of course, the employees of Fannie and Freddie are in a sense being bailed out, presuming they will keep their jobs (although the two CEOs are being bounced).
When the common shares of the companies open for trading on Monday, ‘By rights, the stocks should go to zero,’ says Christopher Whalen, a partner at Hawthorne-based research firm Institutional Risk Analytics.
Under the rescue plan announced by the Treasury on Sunday, the common shares might eventually have some value. But it could take years to know for sure. With that kind of uncertainty the stocks will be suitable now only for the rankest of rank speculators. (Actually, that has been true for weeks. Yet Fannie shares closed at $7.04 on Friday; Freddie closed at $5.10. Look out below on Monday.)
Likewise, the companies’ preferred shares -- which paid hefty dividends and were viewed more as bonds than stocks -- could well end up worthless, depending on how much taxpayer money Fannie and Freddie require to stay solvent. The dividend payments will cease.
Standard & Poor’s and Moody’s Investors Service on Sunday slashed their credit ratings on the companies’ $36 billion in preferred stock to the level of ‘highest speculation, lowest quality.’
That’s a bailout? The Treasury’s willingness to sacrifice the preferred-stock investors actually could mean more trouble for the financial system because the shares were favorite investments of some regional banks and insurance companies. Whoops.
So the common and preferred shareholders are going down.
But the investors who own the debt of Fannie and Freddie have been saved. They’ll continue to earn interest on their bonds and will have their principal repaid in full. There’s your bailout.
As David Kotok, head of investment firm Cumberland Advisors in Vineland, N.J., put it in a note to clients this weekend:
Billions [in Fannie and Freddie debt] are held by state and local governments in the U.S. Similar large holdings are found among the central banks and foreign institutions of the world. They purchased and held this paper based on the fact that the U.S. would honor the guarantee of the federal [agencies], even though the guarantee was not explicit. These buyers had history on their side. The U.S. has not permitted any agency to default. In the end and after all the political wrangling, it is not about to start now. Does keeping the debt holder whole amount to some form of moral hazard issue? The answer is yes. Is it necessary? The answer also is yes.
Here’s one way to think about the debt holders’ bailout: Their willingness to buy the bonds of Fannie and Freddie helped to give us the housing boom. In effect, they put money into the hands of home buyers, builders, mortgage bankers and everyone who ate at the housing trough.
They were giving America what it wanted, and they believed that they had a U.S. government guarantee for doing so.