Two, Two, Two Blogs In One!
The Fannie and Freddie Bail-out: Sooner Than You Think By Elizabeth MacDonald
The taxpayer bailout of the US mortgage finance giants Fannie Mae and Freddie Mac may not happen next year.
It may happen by the end of this quarter.
Fannie and Freddie either own or guarantee nearly half of all U.S. mortgages. The two have had a history of accounting misdeeds and of making political donations to elected officials in order to help ease regulatory demands. They have reported record losses over the past year as hundreds of thousands of borrowers around the country go belly-up on mortgages.
The two issue debt to refinance maturing securities that grease their $1.5 tn book of business and also to buy mortgages.
Fannie and Freddie have to repay $223 bn in bonds due by the end of the quarter, $120 bn at Fannie and Freddie, $103 bn, according to company reports. The problem is, the two are pricing their debt at gut-wrenching spreads above Treasuries, with the five year at Freddie yielding 1.13 percentage points above similar term notes.
Compare that to the 106 basis point spread when the markets were suicidal in March after the Federal Reserve’s orchestrated, shot gun wedding between JPMorgan Chase and Bear Stearns. Why the higher yield now? Because central bankers around the globe, notably in China, have backed off buying their debt, treating it like kryptonite.
Now this $223 bn is an outsized amount of debt that will cause more than acid reflux in the already stretched to the limit bond market. And it must make you rethink Treasury Secretary Henry Paulson’s “bazooka-nomics” approach to providing an unlimited, open-ended taxpayer backstop to these two publicly traded companies, whereby Paulson halfheartedly placed a bet that an open-ended commitment would calm the markets down and cause the two mortgage companies’ shares to go up so long as Wall Street believed the government would rescue them at all costs.
The way these two companies recklessly built and operated their Ponzi-type business model boggles the mind. Teetering atop their combined $54 bn net worth is a breathtaking pyramid of debt and assets, $1.5 tn. That capital amounts to less than 1% of the mortgages they either own or back. Would you keep just one dollar in the bank to fund a $100 loan?
Instead of shutting the spigot off, the two bought subprime and Alt-A securitizations through 2007 when the housing bubble burst, picking up the slack for banks when Wall Street shut down its printing press factory cranking out a drunken daisy chain of asset-backed paper. This is beyond impenetrably stupid. It’s obscene.
The second reason why I think the taxpayer bailout is coming faster than expected is because of the problem with Fannie and Freddie’s preferred shares. Preferred shares are a form of investment that are different from common stock, as the shares offer a dividend that is paid before any dividends are forked over to common stock investors, though the shares do not carry voting rights as common stock does.
Of paramount importance is keeping the preferred shareholders intact, as $36 bn of these investments are held by regional banks around the country, who have counted these shares as part of their regulatory capital cushions.
Reports indicate that the Federal Reserve has been pressuring the Treasury Department behind the scenes not to adopt a rescue plan for Fannie Mae and Freddie Mac that would zero out the value of their preferred shares, as doing so would ignite a cascading effect of losses at the regionals and the need to raise even more capital to fill the potholes blown open by the dramatic drops in value in the preferred shares. Moody’s slashed ratings on preferred stock of Fannie and Freddie last Friday, to Baa3 from A1 on Aug. 22
If the US government has to rescue Fannie and Freddie, the existing preferred shares would either be subordinated to any taxpayer-owned equity stake in the two, or the preferred shareholders would be either partly or wholly wiped out.
JPMorgan Chase already reports it expects to take a $600 mn loss on its preferred shares in its third quarter.
According to SNL Research, among insurers, American International Group and Hartford Financial Services Group are the largest preferred stockholders of Fannie and Freddie, as of year-end 2007, with AIG holding $313.99 mn in Freddie Mac preferred shares and $266.73 mn in Fannie Mae preferred stock estimated at fair value. SNL says Hartford holds $136.52 mn in Freddie Mac and $171.61 mn in Fannie Mae preferred shares.
Of the large-cap banks, M&T Bank, Fifth Third Bancorp and National City have the greatest exposure to Fannie and Freddie preferred stock, notes a report from Keefe Bruyette & Woods. KBW indicates that M&T has $120.0 mn, or 4% of its tangible capital, in the preferred stock of Fannie and Freddie, Fifth Third has $55.0 mn, or 1% of its tangible capital, in their preferred stock (Fifth Third took $13 mn in other-than-temporary impairments on their stocks in the second quarter, SNL says).
KBW says the regional banks have even greater exposures to these shares in Fannie and Freddie. Gateway Financial Holdings has a $38.5 mn exposure to Fannie and Freddie preferred stock, or 34% of its tangible capital. Midwest Banc Holdings has $62.0 mn in preferred shares, or 32% of its tangible capital, and Westamerica Bancorp has $44.5 mn, or 16% of its tangible capital, in their preferred stock.
Five other regional banks have preferred stock positions in Fannie and Freddie that are equal to 10% or more of their tangible capital, the largest of which is Sovereign Bancorp, with its holdings of Fannie and Freddie preferred stock equating to 13% of its tangible capital, SNL notes.
America’s Massive I.O.U. By Brian Sullivan
The Pete Peterson Foundation is making headlines with the promotion of the new documentary I.O.U.S.A. It’s the film that is meant to do for bad fiscal policy and debt what An Inconvenient Truth did for global warming by calling attention to what the organization believes is the greatest crisis facing Americans in the coming decades: America’s massive debt load and financial mismanagement.
According to the Foundation and U.S. Government statistics the total federal burden facing America is more than $52 trillion dollars. That’s trillion, with a ‘t.’ And while the numbers ultimately are complicated, the idea is not. Simply put, what the government is spending on entitlement programs, health care, defense, pensions and other obligations far outstrips what it is bringing in. In short, we owe. A lot.
According to the General Accounting Office, that $52 trillion dollar bill breaks down to $175,000 for every man, woman and child. Since it includes non-taxpaying childen, the actual per household burden works out to be $455,000.
Programs such as social security, medicare and medicaid make up the bulk of the problem. About 42% of the Federal budget goes to these programs. Each has its own crisis. Social security needs to fund the boomers, of whom an average of 10,000 per day will become eligible for benefits over the next twenty years. Taxpayers also pay for one-third of the country’s medical bills through Medicare and Medicaid, and since Medicare began in 1965 the federal share of that bill has tripled.
Peterson Foundation’s President and former U.S. Comptroller General David Walker notes that unless the government gets its fiscal house in order and begins either cutting costs or raising revenues dramatically (or both) in the next decade, the country faces what he calls a “fiscal cancer."