Winners, losers in the U.S. takeover of Fannie/Freddie

Who wins and who loses under the Treasury’s decision to take control of mortgage titans Fannie Mae and Freddie Mac?

Here’s a quick rundown:

--- Owners of both common and preferred shares in the companies could lose it all, depending on how much capital the government winds up putting into the firms to keep them solvent. The government won’t cancel the common or preferred shares, but all dividend payments on the stocks will be halted.

The Treasury will buy a new class of senior preferred stock from the companies. The shares will pay the government a 10% annualized yield initially and will carry with them warrants representing a potential ownership stake of 79.9% in the companies.

The Treasury could invest as much as $100 billion in each company via the new preferred stock over time. The more stock the government has to buy -- to bolster the companies’ capital cushions against mortgage losses -- the more likely it will be that current common and preferred shareholders will lose everything. But that may not be known for years.

There had been some speculation that the government would preserve the current preferred shares (about $36 billion is outstanding between the two companies), because some banks and thrifts have been big investors in those securities. Those institutions now stand to suffer heavy losses if the preferred shares’ market value plunges further.

Bank regulators said today they would work with banks that are stung by losses on Fannie and Freddie preferred stock to "develop capital-restoration plans." But in the short term, a dive in the value of the companies’ preferred shares could worsen stresses in the financial system by further weakening some banks and thrifts.

--- Holders of Fannie and Freddie’s senior and subordinated debt securities will be protected. Their interest payments will continue. This should ease concerns of private and public investors worldwide who own the debt. In effect, they now own U.S.-government-guaranteed bonds.

--- The Treasury also sought to give peace of mind to owners of the companies’ mortgage-backed securities. The Treasury will begin buying some of those bonds in the open market, seeking to bolster the value of the securities by providing another source of demand.

The Treasury expects its initial purchases of mortgage-backed securities to total $5 billion. The purchases and management of the bonds will be handled by independent asset managers, under contract with the government. (There's a win for Wall Street.)

Because the government expects to earn more on the bonds than its cost of borrowing to buy the securities, "There is no reason to expect taxpayer losses from this program, and it could produce gains," the Treasury said in a statement outlining the plan. But that will depend on the level of defaults and ultimate losses on the home loans backing the bonds that the Treasury buys.

--- The government hopes that its plan will bring down mortgage rates, which have remained elevated over the last year despite the Federal Reserve's deep cuts in short-term interest rates. The average rate on 30-year conventional home loans now is 6.35%, up from 6.07% at the start of the year.

By removing doubts about the solvency of Fannie and Freddie, Treasury Secretary Henry M. Paulson Jr. hopes to make investors feel more confident about buying the companies' mortgage-backed bonds. That could lower Fannie's and Freddie's cost of borrowing, which in turn could allow them to lower the rates they require on home loans purchased from banks and thrifts.

The Treasury said it expected its bond purchases to generate "increased availability and lower cost of mortgage financing."  But of course, that will be up to the marketplace.

Photo: Treasury Secretary Henry M. Paulson Jr. at today's news conference in Washington by Brendan Hoffman/Getty Images

Comments

[jackandjill]

Aha.. isnt this called nationalization. This is the US brand capitalism. Take the money from the people and put it in the pockets of the rich and the businesses. Excellent. Mccain wants less government look what less government is doing under bush.. less goverment to help ppl and more govrnment to help big guns

[roland]

I expect shareholder lawsuits alleging the government is paying far less than fair value (and maybe less than current market value). Will the shareholders win?

[Scott]

The starting mortgage rate should now be the same as the 10-year treasury note. Hooray for nationalization. Free houses for everyone.

[scott]

JackandJill wrote:
"Take the money from the people and put it in the pockets of the rich and the businesses."

Maybe you don't know how to read, but the Rich and the Businesses who hold common stock of these companies will get WIPED OUT = LOSE EVERYTHING if the government uses the "money from the people" to prevent the failure of these GSE (Government Sponsored Enterprises).

It is also quite clear that you dont get what would happen if these GSE's failed. You would not be able to get a loan for your car, a credit-card, and forget about getting a mortgage. Credit/liquidity would completely dry up. These GSE's control half of the us mortgage market. $5 trillion, or about half of the GNP of the entire country in a year. If they fail, its not the rich who will be hurt, its everyday people like you and me. Your lack of understand of this issue goes as deep as the typical knee-jerk political reaction in the last part of your post.

Before you post again on something of such import, at least READ what is actually printed, to quote the article quite clearly:

"The more stock the government has to buy -- to bolster the companies’ capital cushions against mortgage losses -- the more likely it will be that current common and preferred shareholders will lose everything."

EVERYTHING! how are the rich and the businesses profiting from this rescue? Go read Business Week, you dont belong here.

[pcfriz]

Oh, just great. After forcing fannie and freddy to eat the bad loans of the big banks to rid some of the loans off their backs, all of a sudden fannie and freddy are in trouble. What a surprise! Now these bad loans are on our backs. How do the houses Morgan and Rockefeller get away with this? There is no justice in America and we now qualify as Facists.

[trai_dep]

Since these companies require such massive public infusions, liquidate all shares (they'd have disappeared had the companies gone bankrupt anyway), meet the debt-holders' obligations then KEEP these companies completely non-traded. No more public risks, private profits. AND go after the executives' bonuses and most of their salaries retroactively and investigate for criminal wrongdoing. So long as the well-connected get to skate, and profit, we'll see this crony capitalism recurring.

[Nut Nut]

Remember:
First Fannie and Freddie bought most of the bad mortgages from the banks – the treasury helped them with unlimited amount of money to do this.
Now Fannie and Freddie are "nationalized" with it most of the worthless mortgages from the banks – read: losses are socialised.
Wall Street walks away fine and the taxpayer is screwed.
And the media collectively doesn't tell You about the biggest scam of all times.
America first?

[Joe Taxpayer]

Dear taxpayer,
first Fannie and Freddie bought most of the bad mortgages from the banks – the treasury helped them with "unlimited" amount of fiat money to do this.
Now Fannie and Freddie are "nationalized" with all the worthless mortgages from the banks – read: losses are socialised.
Wall Street walks away fine and the taxpayer is screwed.
And the media collectively doesn't tell You about the biggest scam of all times.
America first?

[Michael]

@ scott

You don't know what you are talking about. This is a classic example of the hypocrisy of free market, small government capitalists having it both ways. These neocons tout deregulation and free markets... until that fails. Then they remove the risk of collapse by a government buyout (nationalizing the home lending business just as their arch enemy Hugo Chavez would do to stabilize the economy.) How much money do you think the investors would be able to pull from Fannie and Freddie when they go bankrupt? They, along with everyone who has a home mortgage with them, would loose their shirts. This buyout is the only change they have of recuperating investment. Read the article. They will stop paying dividends for a term. They didn't say they will loose their stock. It is morons like you who should question the policies of the do-as-I-say and not-as-I-do so called conservatives. Constantly shifting the rules to their benefit. Can't wait until the coming election.

[Liz Wetzel]

Scott wrote : but the Rich and the Businesses who hold common stock of these companies will get WIPED OUT = LOSE EVERYTHING if the government uses the "money from the people" to prevent the failure of these GSE (Government Sponsored Enterprises).

READ THIS SCOTT!!

Holders of Fannie and Freddie’s senior and subordinated debt securities will be protected. Their interest payments will continue. This should ease concerns of private and public investors worldwide who own the debt. In effect, they now own U.S.-government-guaranteed bonds.

Freddie and Fannie Holders are the rich, now getting help from the government. read before you bark.

[Satan]

To appreciate what this "rescue" of Bear Sterns and Fannie and Freddie means, repeat this mantra as your wallet is made lighter:

Privatize the profits, socialize the losses.
Privatize the profits, socialize the losses.
Privatize the profits, socialize the losses.

[Angry]

Why is anyone surprised? This is how it works:
1) Banks make exorbitant loans to people who they know can not afford to pay them back.
2)Fannie May, Freddie Mac & Wall Street immediately buy all the bad loans.
3)Taxpayers bail out FM, FM & Wall Street.
4)Banks and their officers get to keep all the money they stole.
5)They close the parks near my house because there isn't any funding left.

Make no mistake about this, money does not just disappear. Money was deliberately funneled from our government to the pockets of the wealthy. (Meanwhile, God forbid we should have national health care...THAT'S SOCIALISM.) How much longer are people going to buy into this notion that engorging the wealthy with even more money is good for all of us??? Coolige=depression, Reagen=recession, Bush=recession, hmmm, trickle down economics, hmmm.

[Michael Karton]

Open Letter to Secretary Paulson

Dear sir:

You confuse the end of your world with the end of the world.
You confuse feeling good with doing good.
You confuse heroic measures with legitimized grand theft.
You are bankrupting our country
You are debasing our children’s future.
You are protecting the guilty and punishing the innocent.

PLEASE.
STOP.

Stop lying to us for our own good.
Stop soothing our fears and manipulating our confidence with doctored statistics and meaningless bromides. Our problems are not psychological; they are financial.

Stop reassuring us and misleading us. People act on your words. Less than two months ago, you assured us that Fannie and Freddie are fine. Some believed you and invested in these corpses, just as you wished. Will you cover their losses, or only the losses of big lenders and investors? You told Congress that you would not need to use the powers which you sought because those powers would convince investors that all is well. But all is not well, is it? It was just a set-up.

You did nothing for two years except to tell us that subprime is contained, that lenders will lose perhaps $50 billion, and hat the credit crunch will not contaminate the rest of the economy. Today you said that the economy will not recover until housing does. And you have the gall to tell us that after 2010 we will make a profit on our “investment.”

LIAR.
STOP.

I Beg you. You have already cost us hundreds of billions of dollars propping up the big players (and only the big ones). You took their garbage loans in exchange for our collective full faith and credit. You gave them cheap money at our expense and they make greater profit on each new loan. (They didn’t lower loan rates when the Fed rate dropped. Imagine that.)

Don’t tell us again that it would be worse otherwise. This is mere fearmongering, and on a far greater scale that of the naked short sellers you railed against. I don’t believe you. Banking will not die; only your banks will. Other banks will rise quickly, and the government can help. The panic of 1907 was shortly followed by the roaring twenties.

Since you can’t make it all better no matter how much of our money you throw at the lenders, at least don’t make it worse for the rest of us. If we must bail out foreign investors, then so be it. That is a political decision. But we do not have to bail out domestic investors who cynically invested in Fannie and Freddie because they knew they could not lose.

If you do not stop bankrupting us to protect a bankrupt system, your name will live in infamy: The Bankrupter of America. I will do everything I can to ensure that schoolchildren for decades to come will ridicule your progeny for their evil ancestor.

[country banker]

Liz is correct. Even though common and preferred equity will likely become wortlhless, there were private investors in Fannie and Freddie debt instruments who were bailed out, including Pimco and Gross. What Paulson could have done and still should do, is puchase Fannie and Freddie outstanding debt in the marketplace, which trades at a discount. Why let private, competent investors buy the debt at a discount and then have the taxpayer prop up the debt. A good public servant would have bought the debt at the lowest price possible, a discount. The taxpayer could recapitalize the companies via the discounts. If the GOVERNMENT/Taxpayer would have also included a condition to their participation as follows: We will buy Fannie and Freddie debt at 80% of face amount(or some other number) and further clarify that the U S Gov't does NOT GUARANTY fannie and freddie debt and will not rescue these companies, you would have seen debt owners flocking for the deal limiting their haircut to 20%. The debt investors 20% loss would be the new equity restoring the GSE capital to positive number. If that is not enough, raise the haircut above 20%. Paulson blinked.

In response to Angry, yes this is socialism but national health care is also socialism. all socialism is bad for America.

[Dion]

The two fannies should be left to implode by themselves. All this government buyout and or rescue makes the NEXT occurance for investors have a notion that there is no risk involved and the Big G will again come to the rescue. My gosh where does it end? As people have written before...its socialism when you want it via a toggle switch. As another said we need universal healthcare for everyone irregardless of their financial status. The ones who are really getting the good deal are all those CEO, CFO C(fill in the blanks) who got paid BIG bucks and didnt suffer like the little people. If this was Russia you know how they would deal with this people to people wise....

[Robert Baldwin]

Some good posts here.

I hope that some of those conversant with the workings of this industry will

A. Write up explanations of what is going on which can be read by those without a finance background, without dumbing down so far that the mechanics are lost

and

B. Press to get the explanation out to the public.

I don't have a finance background. I'm *guessing* that some sort of "socialize the losses" is going on (Wall Street loves that) but the who, how, and why of "we must bail out Wall Street again" is something I don't have the background to parse.

Can anyone tell me if the owners of Fan/Fred (shareholders) are getting bailed out or will we (taxpayers) get to use their equity before the our money is put in? Where does the shareholder equity go and how does it get moved from the former owners to the party doing the bailout? (effectively that's us).

I don't see why we should be rewarding mismanaged companies by preserving share value, even at $1/share. I've read that Fan/Fred were encouraged to buy sub-prime loans by the gov't, but they weren't _required_ to do that nor were they required mismanage themselves into bankruptcy.

In the end it looks like we're getting socialism through the side door.

[Psmith]

I read in articles over the weekend that the reason this announcment came today,Sunday, is that China and other countries own massive amounts of Fannie and Freddie bonds. Foreign investors had refused to buy any more mortgage backed bonds and were actually net sellers of these bonds in the last month.

It was important to reassure China and other countries that the bonds would not default so they would continue to buy mortgage backed bonds. Now our banks will have someone to sell mortgage backed bonds to at reasonable rates thus allowing ordinary homeowners ,who have mortgages that adjust to levels that they can't afford, to refinance at a lower fixed rate so they can keep their home.

If more homeowners are able to keep their homes then there will be less forced selling at foreclosure rates which will allow home prices to stabilize sooner.

This is an example of the government acting for the public good.
This receivership plan has been endorsed by both presidential candidates.

I do hope that all voters pressure the government to investigate every mortgage that is defaulted and prosecute any parties guilty of fraud.

Peace to all.

Psmith

[James]

Socialize the losses indeed. So here we go again, Wall Street runs amok, they "financially innovate" us all into bankruptcy all the while pocketing the proceeds. The Fed fails to do anything to control the lunacy until it's too late. Then those in charge throw their hands in the air and declare to Joe Taxpayer that HE must bail them out or we'll all go down the tubes. So we have to ask ourselves the true question ... if these guys are such financial wizards and geniuses how is it they never saw any of this coming? The answer is because they did see it coming and insulated themselves from the disaster while massive amounts of our taxes get funneled to fix their mess because we're left no real choice but to do so. I say let Fannie and Freddie fail. If we MUST use taxpayer funds to fix this mess then let the GSE's fail and put the tens of billions we'd otherwise toss down the chuck-hole into a newly created GSE with heightened congressional oversight. The new GSE's can then choose to buy the nearly worthless former GSE securities if they like or not at all. Trust me folks, in every disaster there is always someone ready, willing and able to step in and buy up the assets at bargain basement prices. As someone pointed out earlier, you can't have it both ways ... either you believe in the free market or you don't. Sometimes from the corpses of dead companies comes stronger, more agile and smarter companies.

[Barry]

Why is the Fed so concerned about defaulting China and other foreign countries that bought vast amount of bonds in the name of two mortgage complexs? Are these proceeds solely for the financing of the American home buyers/owners? Maybe some of it has gone to finance unpopular war against Iraq and more of infusion is needed in the coming years. What happens if China and other foreign countries cut off the blood line? If this is true, we are all paying war tax in disguise.

[worried small retired invester]

I am retired. My financial invester told me that the GSE were safe investments. Not to worry. So a lot of my small retirement account is in bonds for Fmac and Fmae. I am not rich. There are millions of people just like me. If I loose everything, after trying for years to be financially independent in my old age, I will become a burden on my family and society.

Are my bonds protected?

[Donna]

If we really believed in capitalism then risk means risk. Sometimes you win sometimes you loose. In that case bail outs would not exist.

[YourMom]

Does anyone else remember the old days when you were told you could afford a house that cost two and a half times your annual income? In those days I made 6K as a teacher and lived in a 12k house and could have bought one for 15K. Now my neighbors live in 2.5million dollar homes mortgaged to the hilt and no way do they make one million a year. What happened to those standards?

[Jeffrey Goodrich]

Mr. Baldwin (5:04) and Scott (12:11), here is what the plan actually does:

1. The Treasury (taxpayers) invest in the two companies and get preferred shares. This doesn't "wipe out" existing shareholders, but it ensures that the taxpayers get paid before existing shareholders get anything.

2. The two companies get immediate access to unlimited capital. There is no way to know how much this may be as it depends on how the companies' existing loan portfolios perform. If we enter a severe recession and home prices keep declining, the capital required could be greater than $100 billion of taxpayer money.

3. If the government did nothing, existing shareholders would very likely lose everything anyway because the two companies have insufficient capital given the continuing mortgage losses and the natural reluctance of investors to invest more capital in companies that appear to be heading into bankruptcy. So although the plan does not pay shareholders anything yet (so its not yet a "bailout"), it could become a bailout if years down the road the taxpayers are paid back in full and the companies' portfolio performs better than expected.

4. Also, if the government did nothing, the two companies (that account for about 70% of all mortgage originations in the U.S.) would probably fail and would no longer be able to originate mortgages. However, as more than one poster has noted, the government could have formed new GSA's with explicit government backing and accomplished the same objectiive (continued lending for mortgages) without bailing out the existing mortgage lenders. So the plan is also a bailout of foreign investors, sovereign wealth funds, central banks and all others who bought the companies mortgage backed securities and who received a higher than treasury note return for a "risk" that the government has now eliminated. In other words, the lenders just received something for nothing at taxpayer expense.

5. Contrary to Scott's suggestion, most American taxpayers do not own, directly or indirectly, mortgage backed securities. The rich do. So taxpayers are bailing out the rich, pure and simple. Scott, you may argue that this is a good thing because the rich will have more money to "trickle down" to the rest of us, but let's call it like it is, okay?

[martscan]

Jeffrey Goodrich nailed it. A perfect '10'. Way to go Jeffrey!