Yesterday’s frantic activity at the Treasury produced no news but there is widespread speculation that an announcement about Fannie Mae and Freddie Mac will be made in the near future. What do you think?
After the jump, take the reader poll.
Freddie Mac
As investors continue to dump shares of Fannie Mae and Freddie Mac, the debate over a possibly government bailout of the two mortgage giants is raging inside the Beltway. One camp of free market oriented Fed officials is arguing that any rescue plan must wipe-out shareholders and include severe regulatory restrictions on future activity while others, who are viewed as long-time supporters of the GSEs, are arguing that the government should act now to shore up the banks and save regulatory restrictions for a legislative debate later.
We’re told that the debate has become heated, with the two sides scrambling to build alliances and strong pressure from powerful lawmakers and lobbyists seeking to influence the outcome. The free-marketeers at Treasury fear that if they do not reign in the mortgage giants now, while they are at their weakest, Fannie and Freddie will continue to distort markets and put taxpayers at risk once the credit crisis has passed. The supporters of the current structure at Fannie and Freddie more or less agree, believing that if they are able to weather this storm they can emerge newly strengthened.
CNBC’s Jim Cramer yesterday claimed that the stocks of both companies were being pushed down by people with inside information. He called for the SEC to halt all trading in the companies, basically freezing current holders in place. “This is an outrage,” Cramer said shortly after the market closed yesterday. “It’s very clear that someone knows what’s happening.”
Cramer’s call, however, seems misconceived. The situation in Washington DC is still fluid, so it’s not clear that any could know what’s happening. There’s nothing to know beyond the range of possibilities and the widely known fact that the two companies are in trouble.
Cramer expressed outrage that someone apparently leaked to Barron’s earlier this week but leaking information to a newspaper is not insider trading. In fact, it’s closer to the opposite of insider trading, making formerly secret information available to the public. Would investors be better off if they were surprised by moves coming out of DC? Surprise regulatory moves seem unlikely to bolster investor confidence.
Last week we learned that the Treasury Department, shortly after receiving authority to help shore up Fannie Mae and Freddie Mac, hired Morgan Stanley to advise it on the rescue plan. While the Treasury is only paying Morgan Stanley a $94,000 fee for the transaction, Morgan’s role here still raises serious questions. First and foremost: why was Morgan Stanley hired?
We hear that Treasury Department spoke with a variety of Wall Street firms to discuss the advisory role. Presumably, Morgan Stanley got the mandate because it was willing to give up certain market positions that would have created conflicts of interest with its advisory role. (Goldman, which thrives at the nexus of conflicted interest, probably wanted nothing to do with this.)
But the very idea of hiring a Wall Street firm to provide “market analysis and financial expertise” in connection with Fannie and Freddie is strange. No one on Wall Street has the requisite experience for reforming or rescuing government sponsored entities that are now explicitly backed by a bailout package. What’s more, the small size of the advisory fee and its structure provides no incentives for Morgan Stanley to provide advice that will keep Fannie and Freddie out of trouble in the future. Indeed, their client relationships and ties to the securitization and mortgage market may well create incentives for them to push Fannie and Freddie right back into the mortgage bubble inflating business.
We’re sure the people at Morgan Stanley, however, are bright enough and perhaps even honest enough to resist these incentives. But the first thing this deal obviously does is remove accountability for a future failure of Fannie or Freddie. Morgan Stanley’s low fee means that they probably can’t be penalized for giving bad advice. Politicians and regulators, the folks who ordinarily would be held accountable for the collapse of government sponsored entities, will be able to point to Morgan Stanley . In other words, everyone’s ass is covered.
This looks, in short, like a way to free Fannie and Freddie from oversight rather than to provide it. Government guarantees already have freed the companies from market oversight–they simply cannot fail. Now outsourcing the reform has largely freed them from political oversight. Fannie and Freddie may be more autonomous after all this is done than they ever have been before. And once Hank Paulson and his crew–who are genuinely pro-market skeptics with an appetite for reigning in Fannie and Freddie–have passed from the scene, the checks on them may well be removed.
Over the weekend the Senate overwhelmingly passed a the mortgage bailout bill that includes a government rescue plan for mortgage finance giants Fannie Mae and Freddie Mac, grants to states to subsidize local real estate markets and extends government protections for refinancing troubled mortgages. The legislation amounts to one of the most far-reaching government expansions in the real estate and financial markets in decades. Surprisingly, there has been very little public discussion of the details.
So what does the 700 page bill do? We’re not sure anyone knows since hardly anyone–perhaps no one at all–has read the entire thing or had a chance to evaluate how it will interact with existing laws. Here at DealBreaker we’ve discerned a few of the lowlights at Bailout Bill. (If you want to read the bill, click here and God bless you.) After the jump, we run through them.
SEC Chairman Christopher Cox Cox told the Senate Banking Committee that the agency was putting in place an emergency order limiting short sales in Fannie Mae and Freddie Mac with a requirement that the shorted stocks be “preborrowed.”
It’s not immediately clear what this “pre-borrowing” requirement entails, or what sort of authorization short-sellers would need to certify the shares had been preborrowed. Naked-shorting, the practice of shorting a stock without borrowing it first, is currently disallowed in many circumstances. It’s possible the new rule would require investors to show concrete evidence that the shares had been borrowed or eliminate a loophole allowing broker-dealers to accept short trades from other broker-dealers.
Cox didn’t cite any evidence that naked-shorting has become more common in the market for shares of the GSEs. It’s possible that federal officials hope that making shorting more costly, basically weighing down short interest with red tape, they’ll be able to lift the stocks. Yesterday, one prominent Wall Street analyst called for a complete ban on shorting the stocks of these entities.
Cox added that he might go further. “In addition to this emergency order, we will undertake a rule making to address the same issues across the entire market,” Cox said.
I don’t think I’m alone here when I say we’re all still waiting for Jimmy Cayne’s sage counsel on how to save FNM and FRE, but, in the meantime, here are Pershing Square manager Bill Ackman’s recommendations. Seemingly missing from the plan is a part for David Blaine, but we assume it was left out in order to preserve the element of surprise.
How to Save Fannie and Freddie [Pershing Square, PDF]
Fannie Mae and Freddie Mac are often referred to as “government sponsored entitities” but which government are we talking about? As it turns out, the Russians, Taiwanese and other funds sovereign hold most of the bonds of these companies. China, in particular, has between $ 400 billion and 600 billion invested. That represents a whopping 10% of China’s Gross Domestic Product.
Brad Setser argues that the entities might not only be too big too fail, they’re too Chinese and too Russian to fail. Given this huge foreign investment, holding off the collapse of the GSE’s looks like far more than a financial decision. It’s a foreign policy imperative. Hank Paulson, who has spent a lot of time reaching out to China, is no doubt keenly aware of this.
Setser argues that this foreign policy imperative means that there is no way bondholders in the GSEs won’t be made whole. These are, in effect, Treasuries. After the jump, see Setser’s chart illustrating the international holdings of agency debt.
Too Chinese (and Russian) to fail? [Follow The Money]
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