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Fannie and Freddie Insolvent?

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July 10, 2008 – Comments (5) | RELATED TICKERS: FNMA , FMCC

(Reuters) - Mortgage lenders Fannie Mae (NYSE:FNM - News) and Freddie Mac (NYSE:FRE - News) are "insolvent" and may need a U.S. government bailout, former St. Louis Federal Reserve President William Poole was quoted as saying in an interview with Bloomberg.

Wow. Insolvent is a pretty harsh word. I'm no fan of either of those companies, existing, as they do, with privileges they've neither earned nor responsibly utilized, but remarks like this only increase the likelihood that taxpayers will have to shell out a bazillion bazillion to keep these horribly undercapitalized businesses from failing.

Better to let people believe in the taxpayer backing long enough to unwind them in a more orderly fashion, or at least convince some big pools of private money that their capital injections won't evaporate in months. In other words, let private investors take the risk, the bath, and the potential rewards for investing in what is essentially a pair of giant Ponzi schemes.

As it stands now, the two benefit from the implicit taxpayer backing, yet pay out giant amounts of money to bloated execs and private shareholders. That's the worst kind of socialism -- the kind that pretends to help the many, but instead sticks them with the bill for the potential benefit of a few.

5 Comments – Post Your Own

#1) On July 10, 2008 at 10:22 AM, EverydayInvestor (< 20) wrote:

If I had a high position in the government, I would make a statement today, "The government of the United States will not bail out Freddy and Fannie in the event that they require funding." They have been part of the bubble problem anyway, so it would not be a big loss if they imploded. Anyway, it is really obvious that they are insolvent. Excluding tax assets, Freddie has a book value of negative $15b. This doesn't even account for the losses they will take on their risky portfolio of loans.

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#2) On July 10, 2008 at 12:15 PM, dwot (69.85) wrote:

TMFBent everyday they just issue more non-sense.  I tend to agree with Everydayinvestor, it would shut down the new under priced risk they add daily.  There can be no orderly unwinding as long as the risk continues to grow.

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#3) On July 10, 2008 at 9:24 PM, TMFBent (99.81) wrote:

Hey dwot, I said "more orderly," not orderly!

:)

Maybe I am a communist or something, but here's what I think. If we want to have a company that provides this kind of securitization backup for a perceived public good, I can probably agree with that. Probably less necessary now than in the old days, but at times, might be needed.

But if the taxpayers are on the hook with any guarantee -- implicit or otherwise -- they should be getting a cut of the profits. Since it's quite apparent that taxpayers are on the hook for the whole darn thing, there's no reason for this outfit to be paying private investors anything at all.

Re-nationalize it.

Or, if the private investors want their profits and dividends, make it perfectly clear that there's no bailout coming. I'd love to see that announcement. Could you imagine the share price response as investors tried to wrap their head around the fact that they weren't going to be able to socialize the losses?

Sj

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#4) On July 11, 2008 at 2:04 AM, luvb2b (31.18) wrote:

I wonder if you guys understand the ramifications of what you are saying.  Perhaps you ought to take a minute to visit the FDIC website and take a good look at the bank balance sheets.

GSE issued debt is granted a special status which allows it to be held in the "US Treasuries" category of a bank's assets.  If you really drill down on bank balance sheets, you find typically that 15-30% of virtually every bank's assets are held in agency debt.

Imagine for a moment what will happen if (a) Fannie and Freddie are allowed to fail, (b) there is no government organized plan to make good the promises they made on their debt.

All of these agency securities would drop substantially in value - especially the unsecured ones.  If you think there is chaos in the financials now, imagine the hit the banks will take if that debt is suddenly rated junk instead of AA.

Sorry gang, now the game is afoot.  Either the perception of solvency and confidence in the GSEs gets restored, or the government is going to have to backstop the agency debt.   You can bet in the latter case that the common stocks of both FRE and FNM are going to go very close to zero.

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#5) On July 11, 2008 at 8:30 AM, TMFBent (99.81) wrote:

Yeah, ugly things happen when someone finally points out that the king's new outfit is simply his nekkidness.

El dibalo in me says: So it's more important that securities be be rated non-junk, than that that they be non-junk? (Why on earth would anyone have ever though it was OK to pretend that mortgage securities issued by a private company -- currently shown to be far worse than anyone at these places ever imagined, because they ignored common sense in favor of their fancy "models" -- are as "safe" U.S. treasuries?)

This is exactly why we shouldn't be granting any of this debt special status. It distorts the market entirely, encouraging the chuckleheads out there to look for ways to make dog food look like prime chuck. Got crap loans? Hey, just offload them to Fannie and Freddie, because once they put their stamp of approval on the stuff at the other end of the meat grinder, it'll be snapped up by banks because it carries the seal...

Same exact greed game as was played with all those chopped up subprimes and Alt-A tranches carrying ficticious AAA ratings to they could be sold into restricted accounts.

There's a reason I've been telling people to stay away from banks, and it's because the balance sheets are full of complete fictions like these, and projections on these fictions are concocted into "earnings."

The real solution, long run, is to get rid of stupid rules like these, which only encourage cheating, and make banks and others responsible for the stuff on their balance sheets. Don't force a panic sell on reclassification. Let the banks (and their capital providers) decide whether or not what's on the balance sheet is truly worth -- long term -- what the stamp of approval implies.

And I wouldn't bet the common stocks heads to zero. It *should* but there will be plenty of politically-connected bagholders out there complaining that it's not fair for them to lose their investment simply because the company they invested in turned out to be as lousy as it looked.

This is an enormous mess, but I don't think more make-believe solves the problem any more than more cheap money does.

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