So now we know that the Treasury is rescuing Fannie Mae and Freddie Mac by placing them into a conservatorship. The news that something was brewing had been bubbling up since Friday, when the Wall Street Journal first reported that Treasury officials and executives of the two companies were scrambling to put a plan together and planned to announce something over the weekend. Later on Friday the New York Times reported that the plan included placing both companies under a “conservatorship.” Yesterday the Times filled in some more details, noting that the executives of Fannie and Freddie had reached an agreement with Treasury, and that under the rescue plan “the Treasury Department will buy billions of dollars in new mortgage securities issued by the companies and inject an unknown amount of capital into them in quarterly installments.”
An important turning point in the Fannie and Freddie drama, which dragged on through the summer, seems to have come when government inspectors uncovered continuing accounting problems at Freddie Mac. The New York Times reported yesterday that “the Treasury Department concluded that Freddie’s accounting methods had overstated its capital cushion.”
At eight o’clock this morning the Treasury department announced that it would hold a press conference on Fannie and Freddie at 11 o’clock. A tired and noticeably thinner Treasury Secretary Hank Paulson explained the plan. “Paulson looked horrible when he made the announcement,” a readers says. “He clearly has not slept in 72 hours.”
The Wall Street Journal’s Real Time Economics blog has a transcript of Treasury Secretary Hank Paulson’s statement here. So far the exact details of the plans are vague. Here’s Bloomberg’s write up and here’s the Wall Street Journal’s. A “technical briefing” is now underway at the Treasury.
Mortgage Rescue
The Federal Housing Finance Authority will take over as conservator Fannie Mae and Freddie Mac, the government announced as part of its breathtaking rescue of the two housing giants. Under the plan, the current common stocks shareholders will be nearly wiped out and preferred holders will take a hit, the US government will take up to a $100 billion senior-preferred stock position in each company as needed to maintain a positive net worth, purchase mortgage back securities from the two firms, and lend money to the companies through a special facility run through the Federal Reserve.
Treasury Secretary Hank Paulson was very critical of the structure of the companies as quasi-private institutions, which allowed the shareholders and executives to benefit from profits without bearing the economic risks involved. That situation is thought to have encouraged financial recklessness.
“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,” he said.
Our first reaction: It’s pretty odd that the common shares will remain outstanding and continue to trade on the exchanges. How do you value a company run by the government? Paulson’s statement that the common shareholders will be last is not very helpful. Common shareholders are always the last claimants on the residual value of a company.
We’ll update as more details become available. Feel free to add links and your own evaluations below.
Updates:
The AP on who’s running Fannie and Freddie: “Officials announced that the executives of both institutions had been replaced. Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.”
Liz Moyer says Morgan Stanley, which was hired by the Treasury Department to help formulate a rescue plan, uncovered the accounting problems: “Reports Sunday say Morgan Stanley uncovered accounting methods that, while legal, made it look like Freddie, and to a lesser extent, Fannie, had more capital than they would have using different accounting. That discovery is believed to be the catalyst for the Treasury’s actions this weekend.”
Barry Ritholz is working his way through the plan, and has a helpful 10-point summary. He says it looks like holders of common stock get an 80% haircut.
A left-wing web forum wonders why we shouldn’t just describe this as the “nationalization of a major financial sector?” And over at the uber-free market website of the Mises Institute, they totally agree.
The legal authority for Treasury to undertake this takeover was established by Congress on July 30. Over at the Conglomerate David Zaring notes that “it is strange that the government’s authority to bail out business is quite so underspecified, or given at the last minute, given that it has been forced to act this way time and again. If bailouts are going to be a fact of the life of financial crises, Congress really ought to specify the precise authority that government agencies have to engage in them.” On first blush, we think that’s probably wrong: sometimes it’s better to proceed in an ah-hoc, unpredictable way. Creating a structural of predictable bailouts would increase systemic risk and moral hazard.
More updates here and here.
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