As The World Crashes....

Bear Stearns..Gone.

Fannie Mae...Government hearse has arrived.

Freddie Mac...Government hearse has arrived.

Lehman Brothers....A priest has been called.

Washington Mutual...On life support.

Wachovia...Alarm buzzer in Emergency Room is screeching.

AIG...Being rushed to hospital.

Merrill Lynch...High fever.

Goldman Sachs (Where Henry Paulson was Chairman and CEO before heading the Treasury).....Today's closing price: $153.47 per share.

-Robert Wenzel

Alert: Paulson Appears Before Congress Tuesday September 16 Re: Fannie and Freddie

Details:

Tuesday, September 16, 2008, 10:00 a.m. EDT
Secretary Henry M. Paulson, Jr.
Testimony on Recent Regulatory Actions Regarding Fannie Mae and Freddie Mac
Senate Committee on Banking, Housing and Urban Affairs
538 Dirksen Senate Office Building
Washington, D.C.

-EPJ Newsdesk

Rockwell: Stop The Bailout

Lew Rockwell nails it:

Let me state this very plainly: I do not believe for one second that if the government fails to nationalize Freddie and Fannie, that the world as we know it will come to an end. Those who are saying that are trying to scare the population, the same as with every other major demand by the regime. It was the same with Nafta, the WTO, the war on terror, the war on bird flu, the nationalization of airport security, and everything else.

If the government did nothing but sell off the assets of the mortgage giants, we do not know for sure what would happen, but the market has a way of finding value and readjusting. I would expect about 18 months of difficulties. Banks would fail just as many businesses in the free market fail every day. Housing prices would fall more, just as all market prices are subject to change. But the process of readjustment would be smooth and rational. Most important, we would all stop living a lie and believing an illusion

His complete column is here.

-Robert Wenzel

Treasury Statement on Senior Preferred Stock Purchase Agreement Wth Freddie Mac and Fannie Mae

The Treasury issued the following "Frequently Asked Questions" Statement today with regard to its recent takeover of Freddie Mac and Fannie Mae.

September 11, 2008
HP-1131

Frequently Asked Questions:
Treasury Senior Preferred Stock Purchase Agreement

Can the U.S. Congress or the Executive Branch change the terms of the preferred stock purchase agreement?
This preferred stock purchase agreement is a binding legal obligation between two parties. The agreement is designed to prohibit any amendment that would decrease the amount of Treasury's funding commitment or add funding conditions that would adversely affect debt or mortgage-backed securities holders.

Some may speculate that a future Congress could pass a law that would abrogate the agreement. But any such law would be inconsistent with the U.S. government's longstanding history of honoring its obligations. Such action would also give rise to government liability to parties suing to enforce their rights under the agreement.

The U.S. Government stands behind the preferred stock purchase agreements and will honor its commitments. Contracts are respected in this country as a fundamental part of rule of law.

Can the U.S. Congress or the Executive Branch change the covenants in the agreement, such as the covenant requiring the reduction of the companies' portfolios?
As with any contract, the parties to the agreement may modify the covenants by mutual agreement only.

Does the senior preferred stock purchase agreement protect debt and mortgage backed securities issued or maturing after 2009?
Yes. The holders of senior debt, subordinated debt, and mortgage backed securities issued or guaranteed by these GSEs are protected by the agreement without regard to when those securities were issued or guaranteed. Debt and mortgage backed securities issued or guaranteed both before and after December 31, 2009 are protected by the agreement.

If the preferred stock purchase agreement protects senior and subordinated debt securities issued at any time in the future, how can the agreement ever be terminated?
Treasury's funding commitment in the agreement would terminate under three events:

The funding commitment terminates if the commitment is fully funded by Treasury.
If a GSE liquidates its assets, its net worth deficiency is computed at that time and the GSE can call upon the Treasury to fund under its preferred stock purchase agreement. After that final funding, the funding commitment in the agreement would terminate.
When a GSE satisfies all of its liabilities, whether at maturity or by making some other provision for payment in full of its obligations, the funding commitment will also terminate.
Why is the preferred stock purchase agreement limited to $100 billion? Is that enough to protect against even the worst downside scenario? What happens if losses exceed $100 billion?
Treasury deliberately chose a large number to give confidence to the markets.

If Treasury has already received $1 billion in senior preferred stock, how can you say that no investment has been made yet?
The companies each issued $1 billion in senior preferred stock to Treasury in connection with Treasury's commitment to maintain a positive net worth in the GSE. No taxpayer money was spent to receive this stock.

How is it legal for this preferred stock purchase agreement to be valid beyond the December 31, 2009 expiration of Treasury's authority?
Treasury received the preferred stock and received warrants for common stock as of Sunday September 7, 2008 and will not need to purchase any additional shares relative to this agreement. No payments by the Treasury will be made under this agreement until and unless necessary to prevent a negative net worth position for either GSE.

If the Treasury makes payments under its funding commitment, the liquidation preference of the Treasury shares will increase accordingly

What happens to the declared dividends for investors of existing GSE preferred stock?
Dividends actually declared by a GSE before the date of the senior preferred stock purchase agreement will be paid on schedule.

Can the government exercise its warrants whenever it wants, even if it is disadvantageous to the companies?
Yes. Treasury can exercise its warrant for up to 79.9% of the common stock of each GSE on a fully diluted basis at any time during the 20-year life of the warrant.

What do the rating agencies think of this agreement?
All of the rating agencies have reaffirmed the United States' current rating status.


-EPJ Original Document

Is Goldman Sachs Behind Rumors About Lehman Bros.?

Apparently, Lehman's CEO Richard Fuld Jr. think's so.

Fuld called Treasury Secretary Hank Paulson's old firm in June, according to WSJ:

Mr. Fuld grew increasingly frustrated about chatter over Lehman's future and rumors that counterparties were shying away from trading with the firm. At one point, Mr. Fuld contacted Goldman Sachs Group Inc. CEO Lloyd Blankfein. "You're not going to like this conversation," Mr. Fuld told Mr. Blankfein, according to people familiar with their talk. Mr. Fuld said he was hearing "a lot of noise" about Goldman traders who were allegedly spreading negative rumors about Lehman. Goldman declined to comment.

I tell you, honest, it's all coincidence that everyone on Paulson's enemies list is getting blown out of the water: Bear Stearns, Fannie Mae, Freddie Mac, and now Lehman teetering with rumors coming out of Goldman.

It's not that Lehman doesn't have a highly leveraged problem balance sheet. It's just that almost every one on the Street and in commercial banking has the same nutty balance sheets. It's just interesting that the nutty balance sheets are causing the most problems for Paulson's enemies.

-Robert Wenzel

Insurers and Banks Face Huge CDS Losses

This could freeze up the CDS market.

Reports out of FT indicate that the Treasury takeover of Fannie Mae and Freddie Mac has triggered the default of up to $500 billion of Fannie Mae and Freddie Mac credit that could result in billions of dollars of losses for insurance companies and banks who offered credit insurance in recent months.

The potential losses, as well as uncertainty about exactly how the derivatives contracts will be settled and unwound, is putting strains on the unregulated $62 trillion credit derivatives market.

-Robert Wenzel

Paulson's Takeouts: Is Lehman The Last?

It's quite curious that all the major bankruptcies, and the like, that have occurred in recent weeks are all companies that have been out of favor with Treasury Secretary Paulson.

Bear Stearns has been on Paulson's list since they initially refused to help bailout Long Term Capital Management. Paulson has never liked Freddie Mac and Fannie Mae. Now, there is one more ticking time bomb, Lehman Brothers, where George Soros has a 9.47 million common stock position.

Soros is no friend of Republicans and, in fact, is a major backer of Barack Obama. Thus, it is a perfect target for Paulson, but Lehman is fighting hard for survival. Only time will tell how this one plays out,there are strong players on both sides, so it is too close to call, but there is a slight advantage too Paulson.

-Robert Wenzel

A Gross Bailout

In the days leading up to Treasury's bailout of Fannie Mae and Freddie Mac, Bill Gross had been hyperventilating on CNBC and other media venues, aggressively calling for a government bailout of the two. 

FT with  details of the Gross result:

The Bill Gross-managed Pimco Total Return fund reaped a $1.7bn payday following the US government takeover of home loan giants Fannie Mae and Freddie Mac.

While shareholders in Fannie and Freddie suffered deep losses, the world’s biggest bond fund saw its highest ever one-day rise against its benchmark index on Monday, benefiting from the bet made by Mr Gross on mortgage bonds issued by the agencies.

Gross had made a big shift out of US Treasuries and corporate bonds over the past year and into agency bonds, betting that the government would support Fannie and Freddie Mac. By May this year, more than 60 per cent of his $132bn fund was in mortgage debt.

-Robert Wenzel

The Carlyle Group During The Bush Years

The PEU Report cranks out the numbers:

While the average citizen's personal income stagnated under the Bush Presidency, one politically connected private equity underwriter (PEU) made out like bandits. The Carlyle Group went from managing $5.8 billion in assets in 2001 to over $89.3 billion in 2008.

In 2000 the mean household income was $57,047. By 2007 mean household income rose to $67,609.

Carlyle grew its asset base by 1,440% while income rose 18%. Adjusted for inflation, the 18% rise disappears.

...and this all occurred before Randal Quarles gets to perform his magic act for Carlyle's banking division. The players are in the right places. As the PEU Report puts it:

Carlyle senior advisers just landed key jobs as CEO of Freddie Mac and CFO of Wachovia. Why are these moves important? Carlyle expressed interest in buying chunks of troubled banks and government backed mortgage underwriters. They now have people on the inside who can work that same agenda.

-Robert Wenzel

Bunning Rips Bailout Of Fannie And Freddie

"This takeover of Fannie and Freddie is a calamity for our free market system. This arrangement just props them up when they should be dismantled. Fannie and Freddie have been operating under a failed business model and it should not be allowed to continue" said U.S. Senator Jim Bunning in a prepared statement.

"By directly investing in the mortgage market, the Treasury Department is acting like it is a hedge fund. Building up a portfolio of mortgage-backed securities is part of what got Fannie and Freddie in trouble, and now Secretary Paulson is doing the same thing by using taxpayer dollars to prop up housing prices. This is not a free market system. Secretary Paulson is turning America into France of twenty years ago. Simply put, it is socialism.

"Over a month ago Secretary Paulson came before the Senate Banking Committee and told us that just because Congress gave the Treasury Department the authority to bail out Fannie and Freddie it didn’t necessarily mean it would be used. I knew better at the time, though, and pressed Secretary Paulson on the matter asking him why he would request such sweeping powers if he didn’t plan to use them. Not surprisingly the Treasury Secretary couldn’t answer my question. And now we know why.

"As I suspected back in July, Secretary Paulson knew more than he was telling us during his appearance before the Banking Committee. He knew that Fannie and Freddie were in an irreversible state of damage. He knew all along he was going to have to use this authority despite what he was telling Congress and the American people at the time. And yet Congress was foolish enough to give him a blank check for this irresponsible bailout. I hate to say it, but I told you so."

Paulson Had Special Future Tax Break Written For Fannie and Freddie

How's this for a smack on the side of the head. Not only does the government bailout Freddie Mac and Fannie Mae, but if they become profitable down the road, they won't have to pay income taxes on billions of those earnings. This  tax break will amount to tax free earnings for roughly  the first $14 billion of any future Freddie and Fannie net income. Treasury Secretary Paulson had the special tax rule written for Freddie and Fannie, so that they will be eligible for the huge tax break. It won't apply to any other companies.

Paulson ... had the IRS issue Notice 2008-76, which essentially allows the two government-sponsored enterprises to retain all of their [net-operating losses] NOLs, despite a change of control of ownership, tax expert Robert Willens told CFO.com.

Under the tax code — specifically Section 382 — NOLs are severely limited when there is a change of control. But not for Fannie and Freddie, thanks to the change in rules, just for them. The rule is generally in place to prevent acquiring companies from buying up targets just to gain access to their NOLs. The NOLs for Fannie and Freddie are substantial. Over the last four quarters, Fannie and Freddie recorded about $14 billion in aggregate losses.

"I am not saying that the IRS ruling is a good thing, or a bad thing, it is just unusual," added Willens. "Then again, this is a very unusual situation."

One has to wonder what bizarre justification Paulson will have to come up with to explain, after putting billions of dollars of taxpayer money at risk to bailout Freddie and Fannie, that he then grants Frannie and Freddie special privileges so that they won't have to pay taxes on billions of dollars in income. 

Paulson's Formula: Use taxpayer money to bailout Freddie and Fannie. Write in special tax breaks so that Freddie and Fannie, if they turn profitable again (Thanks to the taxpayer bailout), won't have to pay billions taxes.

Fannie Mae and Freddie Mac CEOs to Get Golden Parachutes

Fannie Mae's Daniel Mudd and Freddie Mac's Richard Syron shouldn't have any trouble meeting their mortgage payments, now that they have both been axed.

Mudd and Syron will leave with an additional cash of $7.3 million and $6.3 million, respectively, as part of a severance package, according to an analysis by Paul Hodgson at the Corporate Library.

Randal Quarles Is Sleeping Well Tonight

Things are moving along according to plan for Randal Quarles.

Long time EPJ readers know Quarles as the ultimate insider, and that Quarles always shows up at the right place at the right time.

He has just done it again.

The new CEO of Freddie Mac is David Moffett. Guess where Moffett worked before grabbing the CEO stint at Freddie? Yup, the Carlyle Group, right along side Quarles, in the global financial services sector.

This is all coincidence of course. Paulson's hand was just forced a couple of days ago. And if you believe that,I have some Freddie Mac common stock I'd like to sell you, cheap.

Nonsense Talk From Sarah Palin

Expect more of this kind of talk, whenever she isn't speaking with the help of a teleprompter, since she doesn't have a clue.

This weekend, speaking before voters in Colorado Springs, Palin claimed that Fannie Mae and Freddie Mac had "gotten too big and too expensive to the taxpayers."

At the time of her comments, Fannie and Freddie were not under conservatorship and thus far from being "too expensive," the cost to taxpayers at that point was zero.

Mortgage Rates Fall on Fannie, Freddie Rescue

Mortgage rates are down 35 basis points today on news of a Treasury-led bailout of mortgage giants Fannie and Freddie Mac.

In trading today, the national average on a conforming 30-year fixed mortgage dropped to about 6.20% from last week's 6.55%, according to BankRate.

Hardball From China: "We Don't Know What The Bailout Means"

It's not an official comment from China, but this is certainly a hardball comment out of The People's Republic, which holds some $376 billion in U.S. government agency debt.

"The impact of the U.S. government's bailout of Fannie Mae on China's holdings in the mortgage giants is unclear, an official from the State Administration of Foreign Exchange said Monday," MarketWatch is reporting.

The official, who declined to be named, didn't elaborate, according to MarketWatch.

This is a difficult to figure. Given that the Treasury is basically guarantying the entire $376 billion portion of debt that is Freddie and Fannie paper, what else could the Chinese possibly want?

According to U.S. Treasury Department data, China was by far the largest investor in long-term debt issued by U.S. government agencies, holding $376 billion as of June 2007, which is the latest figure available.

It isn't clear how much China has invested in debt issued by Fannie and Freddie alone.

Your Only Hope: An Open Letter To Fannie and Freddie Shareholders

Dear Fannie and Freddie Shareholders,

You are screwed big time. I don't know what possessed you to continue to hold Fannie or Freddie common stock in recent weeks, when it was clear that Treasury Secretary Paulson was not going to protect  the common stock in a bailout. You obviously weren't reading EPJ. I warned in July, that common stockholders in the two firms would be diluted down to near zero in the bailout.  Maybe you were reading and following Dean Baker's useless advice.

Whatever the case, the worst still might be ahead of you. The Treasury has rights to a 79.9% stake in your companies for capital infusions of  $1 billion each, but it is very likely that further capital infusions may be required which would  dilute your pitiful stake even further.  

Here's what I would do if I were in your situation.

First, I would study the Chrysler bailout of a few decades back.

In December 1979, the Chrysler Loan Guarantee Act of 1979 was approved by the Senate, by a vote of 53 to 44. The Act provided for $1.5 billion in loan over ten years, provided that the company raised another $1.5 on its own. The act became law on January 7, 1980 when President Carter signed it. Chrysler raised the additional $1.5 billion and brought on board Lee Iacocca to run the company. 

With the appointment of Iacocca to head the company, Chrysler launched an all new advertising campaign, with Iacocca becoming one of the most recognizable businessmen in the world. In 1982, Chrysler became profitable. In August 1983, Chrysler paid off the federal loan guarantees seven years early, at a profit of $350 million to the U.S. government as a result of the government selling the warrants they received as part of the bailout package.

There was considerable talk in 1983 that the government should just give the warrants back to Chrysler, so as to not dilute old shareholders. The public outcry at such a possibility killed the idea, and the Chrysler shareholders experienced some dilution.

So what does all this have to do with you?

Freddie and Fannie are highly leveraged companies which means that when the housing market turns around (and it will at some point), Freddie and Fannie will become very profitable. If you can stop the Treasury from converting their preferred stock, which is where the dilution problem is for you, you are going to make a lot of money.

But to even attempt to stop the conversion, you need to start now to form a lobby group. Your  approach will have to be much more sophisticated than the Chrysler effort. You will need good lawyers, lobbyists , public relations people  and a good economist (uh, my email address is rw@economicpolicyjournal.com). 

There are very good reasons that you can make a case to the public that the current bailout was done to protect foreign governments at the expense of you guys. China alone holds some $300 billion in Fannie and Freddie debt, they are protected and American shareholders are not, what gives? And the government shouldn't be in the bailout and takeover game anyway.

Stopping the Fed conversion is a long shot, but it is the only shot you have.

Good luck,

Robert Wenzel

Editor & Publisher 

EconomicPolicyJournal.com

In The Time Tunnel With Dean Baker

We weren't going to bring it up, again, that Dean Baker completely blew the Fannie/Freddie call, until we went to his site, where he is taking credit for making the call correctly!!

To pull this off, Baker takes a time tunnel trip back to September of 2002, when he wrote:

If housing prices fall back in line with the overall rate price level, as they have always done in the past, it will eliminate more than $2 trillion in paper wealth and considerably worsen the recession. The collapse of the housing bubble will also jeopardize the survival of Fannie Mae and Freddie Mac and numerous other financial institutions

He quotes this in a post today that he titles: Fannie and Freddie Go Under: Yes, This Was Predictable

He starts the post off with this humble beginning:

Okay, this is a bit of gloating. After having debated the economists at Fannie and Freddie more than a dozen times over the past six years, I am going to take the opportunity to say that I was right and they are bankrupt.

Now, what really occurred is that Baker completely misunderstood comments made by Paulson just a few weeks back, blew the call and cost anyone who acted on his analysis a lot of money. He wrote:

I have yet to hear any explanation from anyone as to why the government is supporting the share price..

I replied to this with:

I have not seen anywhere a government proposal to give money to shareholders. The Treasury has suggested it may have to buy newly issued stock of Fannie and Freddie to keep them alive, but that is far different than buying shareholder stock.

The next Baker post began with this headline:

Yes, Virginia, Henry Paulson is Bailing Out Fannie and Freddie Shareholders

And, he then wrote, which clearly shows he misunderstood Paulson:

The Treasury is telling the markets that it is prepared to buy shares if the stock of Freddie and Fannie fall below a certain level. Without this commitment, short sellers would see these two bankrupt giants sitting there with positive valuations and push their price very close to zero.

I replied to this nonsense with:

I have not seen, anywhere where Paulson says he wants to bailout shareholders. In fact, Paulson will bailout debt holders, but if it comes to a rescue at the shareholder level where the Treasury comes in to buy newly issued Freddie or Fannie stock, current shareholders will be diluted down to pennies in value, for all practical purposes they will be wiped out. Baker just doesn't seem to get this. It really indicates an alarming lack of understanding of basic finance.

Yes, in some crazy Baker time machine, Baker nailed it. In the real world, it's lucky you are following our analysis instead of Dean "Yes, This Was Totally Predictable--Paulson Is Bailing Out Shareholders" Baker.

Update: Treasury Will Have Ownership Rights To 79.9% of Freddie and Fannie

As part of its announced bailout, the Treasury also said its senior preferred stock purchase agreement includes an upfront $1 billion issuance of senior preferred stock with a 10% coupon from both Freddie and Fannie, quarterly dividend payments, warrants representing an ownership stake of 79.9% in each firm going forward, and a quarterly fee starting in 2010.

With the government  getting 79.9% of  Fannie and Freddie for $1 billion, the  initial valuation for the 20% remaining for current comment stockholders will be $250 million, or approximately 25 cents per share for Fannie shareholders and approximately 39 cents per share for Freddie shareholders. And, its likely the Fannie and Freddie will need further capital injections, which means even more dilution.

Treasury Announces Detalis of Freddie and Fannie Bailout; Some Banks Will Be In Trouble

At a press conference held today, Treasury Secretary Henry Paulson outlined the details of the bailout of Freddie Mac and Fannie Mae. Among the highlights. The Treasury will not bailout common or preferred shareholders. The Treasury expects that this will result in trouble for some small banks who hold large preferred positions. The Treasury will ensure that Freddie and Fannie maintain positive net worth by buying Preferred stock in them when necessary. The Treasury will enter the open markets to buy Freddie and Fannie mortgage backed securities, to stabilize these markets.

Here are the details:

First, Freddie and Fannie "will modestly increase their MBS [mortgage backed securities] portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size,"according to Paulson.

Second, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. "This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations. It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares," Paulson stated.

Third, there will be no bailout of common and preferred stock holders. "Market discipline is best served when shareholders bear both the risk and the reward of their investment. While conservator ship does not eliminate the common stock, it does place common shareholders last in terms of claims on the assets of the enterprise.

"Similarly, conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses," said Paulson.

There is clearly concern that some banks holding preferred stock wll will face net capital problems. Paulson said, "The federal banking agencies are assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac. The agencies believe that, while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital."

Fourth, Paulson announced thatan additional step "Treasury is taking today is the establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks".

Finally,Paulson announced that "to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. Additional purchases will be made as deemed appropriate. Given that Treasury can hold these securities to maturity, the spreads between Treasury issuance's and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury's temporary authorities in December 2009."

UPDATE: The takeover also includes the departure of Fannie Chief Executive Daniel Mudd and Freddie Chairman and Chief Executive Richard Syron. The FHFA said TIAA-CREF Chairman Herb Allison will take over as CEO of Fannie, while U.S. Bancorp Chief Executive David Moffett will be CEO at Freddie. Messrs. Mudd and Syron have consented to stay on and help with the transition, and Paulson said he hopes that "the vast majority" of key Fannie and Freddie employees remain will with the firms.

Paulson's full statement is here.

Statement by Secretary Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency Action

Statement by Secretary Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers

Washington, DC--

Good morning. I'm joined here by Jim Lockhart, Director of the new independent regulator, the Federal Housing Finance Agency, FHFA.

In July, Congress granted the Treasury, the Federal Reserve and FHFA new authorities with respect to the GSEs, Fannie Mae and Freddie Mac. Since that time, we have closely monitored financial market and business conditions and have analyzed in great detail the current financial condition of the GSEs – including the ability of the GSEs to weather a variety of market conditions going forward. As a result of this work, we have determined that it is necessary to take action.

Since this difficult period for the GSEs began, I have clearly stated three critical objectives: providing stability to financial markets, supporting the availability of mortgage finance, and protecting taxpayers – both by minimizing the near term costs to the taxpayer and by setting policymakers on a course to resolve the systemic risk created by the inherent conflict in the GSE structure.

Based on what we have learned about these institutions over the last four weeks – including what we learned about their capital requirements – and given the condition of financial markets today, I concluded that it would not have been in the best interest of the taxpayers for Treasury to simply make an equity investment in these enterprises in their current form.

The four steps we are announcing today are the result of detailed and thorough collaboration between FHFA, the U.S. Treasury, and the Federal Reserve.

We examined all options available, and determined that this comprehensive and complementary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection.

Throughout this process we have been in close communication with the GSEs themselves. I have also consulted with Members of Congress from both parties and I appreciate their support as FHFA, the Federal Reserve and the Treasury have moved to address this difficult issue.

Before I turn to Jim to discuss the action he is taking today, let me make clear that these two institutions are unique. They operate solely in the mortgage market and are therefore more exposed than other financial institutions to the housing correction. Their statutory capital requirements are thin and poorly defined as compared to other institutions. Nothing about our actions today in any way reflects a changed view of the housing correction or of the strength of other U.S. financial institutions.

***

I support the Director's decision as necessary and appropriate and had advised him that conservatorship was the only form in which I would commit taxpayer money to the GSEs.

I appreciate the productive cooperation we have received from the boards and the management of both GSEs. I attribute the need for today's action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither. New CEOs supported by new non-executive Chairmen have taken over management of the enterprises, and we hope and expect that the vast majority of key professionals will remain in their jobs. I am particularly pleased that the departing CEOs, Dan Mudd and Dick Syron, have agreed to stay on for a period to help with the transition.

I have long said that the housing correction poses the biggest risk to our economy. It is a drag on our economic growth, and at the heart of the turmoil and stress for our financial markets and financial institutions. Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye toward mortgage affordability.

To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size.

Treasury has taken three additional steps to complement FHFA's decision to place both enterprises in conservatorship. First, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations. It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares.

These Preferred Stock Purchase Agreements were made necessary by the ambiguities in the GSE Congressional charters, which have been perceived to indicate government support for agency debt and guaranteed MBS. Our nation has tolerated these ambiguities for too long, and as a result GSE debt and MBS are held by central banks and investors throughout the United States and around the world who believe them to be virtually risk-free. Because the U.S. Government created these ambiguities, we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holdings of GSE debt and MBS.

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.

Similarly, conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses. The federal banking agencies are assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac. The agencies believe that, while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital.

The agencies encourage depository institutions to contact their primary federal regulator if they believe that losses on their holdings of Fannie Mae or Freddie Mac common or preferred shares, whether realized or unrealized, are likely to reduce their regulatory capital below "well capitalized." The banking agencies are prepared to work with the affected institutions to develop capital restoration plans consistent with the capital regulations.

Preferred stock investors should recognize that the GSEs are unlike any other financial institutions and consequently GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly. By stabilizing the GSEs so they can better perform their mission, today's action should accelerate stabilization in the housing market, ultimately benefiting financial institutions. The broader market for preferred stock issuance should continue to remain available for well-capitalized institutions.

The second step Treasury is taking today is the establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Given the combination of actions we are taking, including the Preferred Share Purchase Agreements, we expect the GSEs to be in a stronger position to fund their regular business activities in the capital markets. This facility is intended to serve as an ultimate liquidity backstop, in essence, implementing the temporary liquidity backstop authority granted by Congress in July, and will be available until those authorities expire in December 2009.

Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. During this ongoing housing correction, the GSE portfolios have been constrained, both by their own capital situation and by regulatory efforts to address systemic risk. As the GSEs have grappled with their difficulties, we've seen mortgage rate spreads to Treasuries widen, making mortgages less affordable for homebuyers. While the GSEs are expected to moderately increase the size of their portfolios over the next 15 months through prudent mortgage purchases, complementary government efforts can aid mortgage affordability. Treasury will begin this new program later this month, investing in new GSE MBS. Additional purchases will be made as deemed appropriate. Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury's temporary authorities in December 2009.

Together, this four part program is the best means of protecting our markets and the taxpayers from the systemic risk posed by the current financial condition of the GSEs. Because the GSEs are in conservatorship, they will no longer be managed with a strategy to maximize common shareholder returns, a strategy which historically encouraged risk-taking. The Preferred Stock Purchase Agreements minimize current cash outlays, and give taxpayers a large stake in the future value of these entities. In the end, the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward. To that end, the steps we have taken to support the GSE debt and to support the mortgage market will together improve the housing market, the US economy and the GSEs' business outlook.

Through the four actions we have taken today, FHFA and Treasury have acted on the responsibilities we have to protect the stability of the financial markets, including the mortgage market, and to protect the taxpayer to the maximum extent possible.

And let me make clear what today's actions mean for Americans and their families. Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today.

While we expect these four steps to provide greater stability and certainty to market participants and provide long-term clarity to investors in GSE debt and MBS securities, our collective work is not complete. At the end of next year, the Treasury temporary authorities will expire, the GSE portfolios will begin to gradually run off, and the GSEs will begin to pay the government a fee to compensate taxpayers for the on-going support provided by the Preferred Stock Purchase Agreements. Together, these factors should give momentum and urgency to the reform cause. Policymakers must view this next period as a "time out" where we have stabilized the GSEs while we decide their future role and structure.

Because the GSEs are Congressionally-chartered, only Congress can address the inherent conflict of attempting to serve both shareholders and a public mission. The new Congress and the next Administration must decide what role government in general, and these entities in particular, should play in the housing market. There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes. And policymakers must address the issue of systemic risk. I recognize that there are strong differences of opinion over the role of government in supporting housing, but under any course policymakers choose, there are ways to structure these entities in order to address market stability in the transition and limit systemic risk and conflict of purposes for the long-term. We will make a grave error if we don't use this time out to permanently address the structural issues presented by the GSEs.

In the weeks to come, I will describe my views on long term reform. I look forward to engaging in that timely and necessary debate.

Alert: Treasury To Detail Freddie/Fannie Takeover, Sunday

WSJ is reporting that the Treasury is expected to announce early Sunday afternoon details of a plan under which regulators will effectively take temporary control over Fannie Mae and Freddie Mac.

Barney Frank Confirms Fannie/Freddie Interventions

Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, said in a statement that Treasury Secretary Henry Paulson "intends to use the powers that Congress provided it" in a law passed in July to enable Fannie Mae and Freddie Mac to keep functioning.

According to AP, Frank spoke with Paulson late Friday,but said he did not "know the details of the proposed interventions," and a Treasury spokeswoman declined to comment.

Government Takeover of Freddie and Fannie

Senior officials from the Bush administration and the Federal Reserve informed top executives of Fannie Mae and Freddie Mac that the government is preparing a plan to seize the two companies and place them in a conservatorship, officials and company executives briefed on the discussions told NYT.

Developing....

UPDATE: Sounds like Freddie and Fannie will be run on an interim basis by the Federal Housing Finance Agency.

UPDATE 2: From WaPo:

The value of the company's common stock will be diluted but not wiped out while the holdings of other securities, including company debt and preferred shares, will be protected by the government...

Instead of giving each company a big capital infusion up front, the government plans to make quarterly infusions as the companies' losses warrant, the sources said. This would be an attempt to minimize the initial cost of the rescue...

Hot Buzz: Government Moves On Fannie, Freddie

It appears that the  goverment is about  to pump capital into Fannie Mae and Freddie Mac, in what is sure to be a near takeover of the two agencies. 

A meeting was held this afternoon at the Federal Housing Finance Agency. Richard Syron CEO of Freddie Mac and Daniel Mudd CEO of Fannie Mae were summoned to it, according to Deborah Soloman and Damian Paletta at WSJ.  Also attending were the Fed's Ben Bernanke and Treasury Secretary Henry Paulson.

Reportedly, Mudd and Syron will be axed as part of the Treasury move.

An announcement could come as early as this weekend.

Specific details of Treasury's plan and specifics of the capital infusion are not yet available. The plan is expected to involve "a creative use" of Treasury's authority, according to WSJ. More than likely common stock shareholders will be crushed, with their shares diluted down to near worthlessness.

It looks like a done deal, more details here.

Treasury Responds to Rumors on Freddie and Fannie

The U.S. Treasury is denying financial market rumors that an announcement regarding mortgage finance companies Fannie Mae and Freddie Mac was imminent.

A Treasury spokeswoman, asked by Reuters about the rumors, said there would be "no announcement today."

The Secret to Survival for Freddie and Fannie....

...more debt, higher leverage.

Treasury Secretary Paulson, perhaps unwittingly, has created a a life saving escape hatch for Freddie and Fannie.

The Treasury has made it clear that it will guarantee Freddie and Fannie debt. It has made it clear, it will not back up common stock of the two companies, and the Treasury has been hazy as to where it stands on preferred.

Thus, the market has no interest in common stock or preferred, BUT because of the Treasury guarantee on Freddie and Fannie debt, the market will buy their debt.

This was proven by today's successful sale of $2 billion of short-term debt by Freddie. It sold $1 billion each in three- and six-month bills,at a yield of 2.58% Though it was a bit expensive since this was about 90 basis points more than similar-maturity U.S. Treasuries.

Nevertheless, with the debt window open, Freddie and Fannie can survive. The big question remains will they be willing to test the markets willingness to buy long term debt and thus raise more permanent money.

Banks With Heavy Exposure To Fannie and Freddie Preferred Stock

In a bailout of Freddie Mac or Fannie Mae, the Treasury is likely to protect their preferred stocks.

Just in case, though, here is a list of banks holding significant amounts of Fannie or Freddie preferred shares

From WaPo:

Some of the banks with the biggest exposure include Regions Financial, which has an estimated $200 million, M&T Bank with $161 million, and Astoria Financial Corp. with $83 million, according to Fox-Pitt Kelton, an investment bank.

Relative to the billion dollar hits some banks have been taking these numbers are small, but the thinking is that, if the preferred become problems, depositors may flee these banks in fear of what else might be under the rug.

Bond Fundraising Costs Soar

A combination of fears from the financial crisis as it stands and the fact that money supply over the last 4 months has grown at a tepid 2.5% is resulting in the climbing cost to borrow from the bond market.

Many banks and companies are paying more to raise money in the bond markets than at any time since the recession in the early 1990s amid signs that the financial crisis is deepening.

Growing worries about the health of many banks, rising default rates and deteriorating economic conditions across the world are forcing yields up as investors demand higher risk premiums to buy bonds.

Spreads for US investment grade banks and companies rose to the highest level last week since the early 1990s, according to Lehman Brothers.

In Europe and Asia, spreads for many investment grade companies are at 10-year highs, according to Lehman.

Some of those facing the highest spreads are Fannie Mae, Freddie Mac, Citigroup, American Express, AIG and Deutsche Telekom.

Chef Paulson Simmers Freddie and Fannie

Simmering is a cooking technique in which foods are cooked in hot liquids kept at or just barely below the boiling point of water (at average sea level air pressure), 100°C (212°F). To keep a pot simmering, one brings it to a boil and then adjusts the heat downward until just before the formation of steam bubbles stops completely. Water normally begins to simmer at about 94°C (200°F).

Treasury Secretary Paulson is in the kitchen and Frannie and Freddie are in the pot. As Wall Street watches Freddie and Fannie simmer, no sane investment banker, money manager or private equity firm will buy an equity position in these GSE's until it is clear how Chef Paulson plans to serve his dish.

Charles Duhigg and Vikas Bajaj at NYT explain:

Anxiously awaiting a move by the Treasury Department and spurned by large investment firms, Freddie Mac and Fannie Mae find themselves unable to raise capital and with little ability to maneuver.

Treasury officials have reviewed multiple plans for intervention, according to people who have spoken to top Treasury officials. But they have not identified a set of triggers that will compel a government bailout. Nor have they indicated to Freddie Mac or Fannie Mae executives when a bailout may occur or what form it may take.

As a result, investors are telling Freddie Mac and Fannie Mae that they remain unwilling to purchase new shares in the firms.

“We’re in a Catch 22,” said an executive with one of the mortgage firms who was not authorized to speak to the media. “As long as there is uncertainty over Treasury’s plan, we can’t raise money, and as long as we can’t raise money, there’s going to be more and more speculation about Treasury’s plan.”...

As speculation mounts about if and when the government will intervene, Treasury Secretary Henry M. Paulson Jr. has declined to discuss with the companies or other outsiders how a bailout might look. People close to Mr. Paulson and other Treasury officials say those policy makers are constantly taking the temperature of market participants, and will act when they think that confidence has eroded to the point that it damages the firms’ capacities to buy and sell mortgages.

Make no mistake. When Paulson moves Freddie and Fannie from the pot to the platter, it will signal the beginning of a feast. Champagne will flow, grapes will be dropped into the mouths of invited guests by exotic women and money will be made, lots of it.

It will be interesting to see who is on the guest list, but rest assured it won't be you or me.

Economist: The Fannie and Freddie Bailout Will Cost At Least $1.3 Trllion

Economist Don Rich cranks out the numbers and writes:

Between 2001 and 2007, Fannie and Freddie purchased or guaranteed $700 billion of Alt-A and subprime loans. Given the default rates on these loans — and the fact that the price of the housing that is the ultimate security of the loans will, for reasons demonstrated below, fall by at least thirty percent — this alone implies a loss for Fannie and Freddie on the order of $210 billion.

Fannie and Freddie acknowledge already-impaired loans on the balance sheet of $19 billion, which they have used creative accounting to avoid deleting from the shareholder equity account. This means that Fannie and Freddie have a maximum of $64 billion in capital remaining.

Given the inevitable losses on the Alt-A/subprime portion of their portfolio, it must be the case that if the federal government, as it is doing, guarantees Fannie and Freddie's solvency, the difference between the loss and the capital to be made up by the government (i.e., the taxpayers) must equal, not $25 billion but $147 billion...

the Case-Shiller Index in its entire 110-year history had never crossed 140 until the recent bubble. In 2006, it reached 210. Every single real-estate bubble in the past has at best been followed by a fall back to at least the 110 level in the postwar era, although the bubble preceding the Great Depression witnessed a fall to 60.

What this means is that in the best-case scenario, real-estate prices have to fall in the medium to long run by almost half.

Now consider Fannie and Freddie. Just looking at their portfolios on the balance sheet without the guarantees, let us accept (for no particular reason other than a desire that the reader sleep better at night) that real-estate prices only fall by thirty percent.

Well, since Uncle Sam is now committed to "doing whatever it takes," that is a loss right there of $1 trillion. This committment to keep financial markets open as usual is made in spite of the overwhelming evidence that what we have been taught is usual is in fact delusional, given that Fannie and Freddie own $3 trillion and change of mortgages...

The more realistic scenario is actually worse. Fannie and Freddie own and guarantee a total of more than $5 trillion in mortgages.

Given the long-run historically plausible equilibrium values of residential real estate as embodied in the Case-Shiller Index, that means that the taxpayer loss definitely reaches $1.3 trillion, easily ranging up to $1.6 trillion.

Unfortunately, that is the good news. The bad news is that if real-estate prices were to replicate the Great Depression (as would surely occur in the case that hedging instruments of Fannie and Freddie were to catastrophically fail due to counterparty failure — and given the absurdly low risk premiums on credit-default swaps at the height of the bubble, such an event cannot be considered unlikely) the Case-Shiller Index tells us that the loss to the taxpayers could exceed $2.5 trillion dollars.

Buffett: Reasonable Chance Fannie and Freddie Will Be Wiped Out

On CNBC's Squawk Box Warren Buffet said that there's a "reasonable chance" that Fannie and Freddie's equity will be wiped out. They keep existing because they're backed by the government, and the government should continue to support them, expect for the equity portion. He notes that Berkshire had been a big holder of the GSEs before selling the entire stake around 2000 and 2001.