The 2009 Budget Deficit Mess and China

The Council on Foreign Relations house economist, Brad Setser, has crunched the numbers on China's purchases of Treasury securities and has come up with this data:

1) China has bought — according to the US TIC data — about $150 billion of Treasuries over the last three months of data. Annualized that is $600 billion, a huge sum. That data only runs through November. However, ongoing growth in the Fed’s custodial accounts implies that this basic pattern continued in December (data/ graphs can be found here)

2) The surge in China’s Treasury purchases has come even as China’s reserve growth has slowed. It consequently reflects a reallocation of China’s portfolio towards the safety of the Treasury market more than a surge in Chinese demand for dollars — and it may also reflect a decision by China’s reserve managers to shift funds out of the hands of private fund managers after Lehman (a decision that has had the effect of increasing reported Chinese purchases of US assets).

3) Once the shift in China’s portfolio toward safety ends, the pace of China’s purchases of Treasuries is likely to fall. It is hard to sustain a $600b annual increase in your holdings of Treasuries if your reserves aren’t growing. Hot money outflows will bring China’s savings into the global market, but in a less direct and harder to track way.

4) The Treasury has increased its issuance even faster than China has increased its purchases. The US is consequently selling more Treasuries to everyone, not just to China. The increase in China’s holdings of Treasuries consequently accounts for a significantly smaller share of the net increase in the supply of marketable Treasuries than in the past (Data here)

He also warns about the 2009 deficit:

One thing though is quite clear but strikes many as counter-intuitive: the large US fiscal deficit in 2009 will need to be financed primarily from domestic sources not from China. Let me put it this way. China currently has — in my judgment — about $900 billion of Treasuries. That is a truly staggering sum. But China also didn’t buy them all in a year. The US will need to sell more than $900 billion of Treasuries to cover its 2009 budget deficit. And China isn’t going to double its Treasury holdings in 2009 …

Thus, a number of conclusions can be made from this data. First, given the HUGE deficit financing that the US will conduct in 2009, it is truly bizarre that the Obama Administration wants to pressure China into providing less support for the dollar, i.e., They want China to buy less Treasury securities than they would without the pressure.

Second, much of the Treasury securities that have been absorbed in the second half of 2008, have been the result of a flight to safety. Once the markets calm down, the flight to safety will be reversed. Thus, not only will the Treasury market have to deal with newly issued Treasury securities as a result of a $900 billion deficit, but with the liquidation into the market of hundreds of billions of Treasury securities purchased in the second half of 2008.Can you say higher interest rates and inflation in the same sentence?

There is no way that so many Treasury securities will be able to be absorbed into the market at anywhere near current rates. Thus, we are likely to see a combination of rising interest rates and huge Federal Reserve purchases of Treasury securities. It will all be very inflationary.

The only sane option is for the United States government to declare bankruptcy. Super-inflation or bankruptcy, those are the only options folks. The empire is crashing. Talk of larger "stimulus" packages, and "we will worry about the deficit later", is insanity. The deficit is not going to wait. Be ready.

Timothy "Soprano" Geithner: Punk Treasury/Goldman Enforcer?

Treasury Secretary nominee Timothy Geithner, who in the past has been slow sending the Treasury tax money owed (It slipped his mind, or something) is now a reported punk enforcer for the Treasury/Goldman Sachs Family. Chris Whalen of Institutional Risk Analytics reports (Via Henry Blodgett)

To me, the apparent conflict of interest between Geithner, Hank Paulson, Robert Rubin and other principals of Goldman Sachs is Topic A for the Senate confirmation hearing. In particular, I'd like to see Paulson finally respond to the numerous FOIA requests from news organization for his telephone and email logs.

In particular, the Senate needs to focus on the reported activities of Geithner on behalf of Goldman Sachs to stop members of the media from reporting on Geithner's apparent rescue of GS by bailing our AIG. I understand that Geithner threatened a member of the NY press corps because of that journalist's reporting on the AIG rescue. I have promised said journalist not to reveal the writer's name for now, but I hope to see that writer in touch with members of the Senate minority early next week.

Gong Show Time for Timothy Geithner

It's roasting the nominees season.

Timothy Geithner, Barack Obama's nominee to head the Treasury, didn't pay Social Security and Medicare taxes for several years while he worked for the International Monetary Fund.

The IMF and World Bank reimburse employees, including U.S. citizens, for their U.S. income taxes. They don't, however, make contributions toward Social Security and Medicare taxes, which individuals are expected to pay on their own.

In 2006, the IRS conducted a letter audit of Geithner's 2003 and 2004 taxes and concluded he owed taxes and interest totaling $17,230, according to documents released by the Senate Finance Committee. He paid up and the IRS waived the related penalties.

But, according to WSJ:

During the vetting of Mr. Geithner late last year, the Obama transition team discovered the nominee had failed to pay the same taxes for 2001 and 2002. "Upon learning of this error on Nov. 21, 2008, Mr. Geithner immediately submitted payment for tax that would have been due in those years, plus interest," a transition aide said. The sum totaled $25,970.

The Obama team said Mr. Geithner's taxes have been paid in full, and that he didn't intend to avoid payment, but made a mistake common for employees of international institutions. That characterization was contested by Senate Finance Republicans, who produced IMF documents showing that employees are repeatedly told they are responsible for paying their payroll taxes...

Other tax issues also surfaced during the vetting, including the fact Mr. Geithner used his child's time at overnight camps in 2001, 2004 and 2005 to calculate dependent-care tax deductions. Sleepaway camps don't qualify.

Amended tax returns that Mr. Geithner filed recently include $4,334 in additional taxes, and $1,232 in interest for infractions, such as an early-withdrawal penalty from a retirement plan, an improper small-business deduction, a charitable-contribution deduction for ineligible items, and the expensing of utility costs that went for personal use

Geithner prepared his own tax returns in four of the years in question. Economist Magazine tells us he is, "a quick learner: within a year of joining the New York Fed he could debate the intricacies of monetary policy with academic experts." The current revelations suggests he is either not a quick learner, or a tax cheat---or both.

And don't forget, Geithner once said, “Most consequential choices involve shades of gray, and some fog is often useful in getting things done."

Geithner's biggest problem: The IRS is a division of The Treasury. The folks back home aren't going to be happy with a tax cheat running the Treasury. The blogs are blowing up on this one.

A tentatively scheduled confirmation hearing Tuesday for Geithner was canceled.

But grab a cold one, popcorn and get comfortable in your easy chair. These roastings are about the only time you get your moneys worth from government. It won't matter policy wise whether Geithner is shot in public or given the medal of honor, he is just a tool in the machine. If the heat gets too intense, and he bails, or is forced to bail, the Council on Foreign Relations and the Group of Thirty (Geithner is a member of both) have plenty of other soldier recruits waiting in line. For the powers that be, this is what California's Jerry Brown once called the presidential nomination process, "a Gong Show for the rich".

A new confirmaton hearing is now scheduled for Friday.

Treasury Secretary Paulson Lied to Congress

I don't know how else to interpret this report from WSJ:

Mr. Paulson wanted flexibility to use the money any way he saw fit. Privately, he told his staff that equity injections might be needed. But in public testimony, he all but ruled out that option, describing it as something a government would do for failing institutions, not the solvent ones he wanted to assist.

Of course, as we now know, the money has gone mostly to solvent financial institutions and in the form of equity investments. With Goldman Sachs, Paulson's old firm, and the Robert Rubin wing of Goldman, Citigroup, among the first to get billions from the Treasury.

Treasury Reports On Where Your $700 Billion Is Going

The Treasury Department has hired two big accounting firms to help keep tabs on the government's financial-industry rescue program.

The Pricewaterhouse Coopers contract (below) released by the Treasury Department on Tuesday has blacked-out text in the area covering the firm's bid, and also conceals the name of the PricewaterhouseCoopers partner who signed the deal.

The Ernst & Young contract has no blacked-out sections, just notes saying that two parts of the agreement were redacted. Those were the firm's price quotation and technical quote.

The Treasury Department put out an announcement about a major bailout-related contract with Bank Of New York Mellon. The copy of the agreement (below) that was made public had blacked-out paragraphs in the section covering Bank of New York Mellon's compensation.

Via BailoutSleuth.com

Term Sheet Details Released By Treasury

The terms on which the Treasury will fund banks as part of the Congressionaly approved Paulosn Plan have been released.

Under the program, Treasury will purchase up to $250 billion of senior preferred shares. The program will be available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities that elect to participate before 5:00 pm (EDT) on November 14, 2008. Treasury will determine eligibility and allocations for interested parties after consultation with the appropriate federal banking agency.

The minimum subscription amount available to a participating institution is 1 percent of risk-weighted assets. The maximum subscription amount is the lesser of $25 billion or 3 percent of risk-weighted assets. Treasury will fund the senior preferred shares purchased under the program by year-end 2008.

The senior preferred shares will qualify as Tier 1 capital and will rank senior to common stock and pari passu, which is at an equal level in the capital structure, with existing preferred shares, other than preferred shares which by their terms rank junior to any other existing preferred shares. The senior preferred shares will pay a cumulative dividend rate of 5 percent per annum for the first five years and will reset to a rate of 9 percent per annum after year five. The senior preferred shares will be non-voting, other than class voting rights on matters that could adversely affect the shares. The senior preferred shares will be callable at par after three years. Prior to the end of three years, the senior preferred may be redeemed with the proceeds from a qualifying equity offering of any Tier 1 perpetual preferred or common stock. Treasury may also transfer the senior preferred shares to a third party at any time. In conjunction with the purchase of senior preferred shares, Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15 percent of the senior preferred investment. The exercise price on the warrants will be the market price of the participating institution's common stock at the time of issuance, calculated on a 20-trading day trailing average.

Companies participating in the program must adopt the Treasury Department's standards for executive compensation and corporate governance, for the period during which Treasury holds equity issued under this program. These standards generally apply to the chief executive officer, chief financial officer, plus the next three most highly compensated executive officers.

The financial institution must meet certain standards, including: (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. Treasury has issued interim final rules for these executive compensation standards.

Tape Blows Cover On True Treasury Intentions

The new kid at the Treasury hasn't quite learned you really can't talk in public about what you are really up to at Treasury. New Interim Assitant Secretary of the Office of Stability, Neel Kashkari, has been caught on tape providing the true details of what Treasury is up to. This will get him muzzled pretty fast, but it provides us the opportunity to see the scheming going on at Treasury.

Kashkari's statements were posted on YouTube, and now appear to have been removed.

WSJ reviewed the tapes and reports first on the fact that Kashkari considers the executive pay caps demanded by Congress a joke:

As the biggest market intervention in U.S. history made its way through Congress, Neel Kashkari, the Treasury official named this week to run the program, offered assurances to 800 financial-industry players.

Attempts by Congress to make beneficiaries pay for their mistakes, such as placing caps on executive pay, were "quite reasonable" and "a pretty modest hindrance to you," he told them, according to a recording of the Sept. 28 conference call made public on video-sharing Web site YouTube.

Kashkari told participants in the call that lawmakers' interest in limiting executive compensation was "emotional" and "probably the most difficult part of the negotiation" with Congress.

When one industry participant said the caps might discourage participation, Kashkari noted their limited scope, which he called "a pretty modest hindrance to you coming into the program," WSJ reports.

WSJ also reports that the conference call took place the night before the House rejected the rescue plan, on September 28. The plan passed days later on October 3.

The dates are important because Kashkari, according to WSJ, also reported to the financial insiders that, "Our preference would be to try to help healthy banks become even healthier." (My emphasis.)

Remember, the entire focus, at the time, was on buying up bad mortgages and there was no news out publicly about Treasury helping "healthy banks"?

Indeed, I just did a search of the New York Times database and the first time the words "healthy bank" come up in a search is on October 9, where NYT reports that as Part of a NEW "Plan B" that Treasury may take positions in banks, even healthy ones.

This is how NYT reported the story (My emphasis):

Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system, according to government officials...

The American recapitalization plan, officials say, has emerged as one of the most favored new options being discussed in Washington and on Wall Street. The appeal is that it would directly address the worries that banks have about lending to one another and to other customers.

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it...including healthy ones.

This new interest in direct investment in banks comes after yet another tumultuous day in which the Federal Reserve and five other central banks marshaled their combined firepower to cut interest rates but failed to stanch the global financial panic.

As Bob Murphy has pointed out, they haven't even bought one mortgage yet, so how could they have failed at attempting to unlock the supposed frozen market?

"New interest"? "New options" "After yet another tumultuous day"? Then why was Kashkari talking about these details to the securities industry, even BEFORE the first House vote?

A database search of WSJ pretty much shows the same thing, the first time "healthy bank" is used with regard to the takeover of banks is October 10. The only other relevant search that comes up is an Op-Ed piece on 9-26 by John Paulson , a respected Wall Street investment manager--not the Treasury Secretary--, who discusses the Treasury's plan to buy mortgages from all banks. And he would certainly be shocked to hear that two days after his Op-Ed that Kashkari said the Treasury's preference was to help healthy banks, given that John Paulson wrote in his Op-Ed:

By allowing all banks to sell their worst assets to Treasury at inflated prices, taxpayers would be subsidizing healthy banks which have access to private capital (Goldman Sachs, J.P. Morgan, Wells Fargo, and Bank of America, for example) as well as banks that don't have a private alternative. But under a Preferred plan, only banks that don't have a private alternative will be given federal assistance. This would reduce the outlay otherwise required to solve the crisis.

Folks, we have a smoking gun here, you would have to be blind not to see that the Bernanke-induced crisis is being used by Paulson to funnel money to Goldman Sachs and his other crony favorites. The plan all along was to help out "healthy banks". It's on tape from the interim Assistant Secretary of Stability. Yeah, crisis and fear alright. Every time they utter those words, they move more of the $700 billion closer towards Goldman Sachs' vault.

UPDATE: There is a poor quality audio tape of the conference call on YouTube. Here is Part 3 where at the 9:00 minute mark the mention is made that healthy banks will be preferred. Thanks, Anthony.

Treasury Announces Guaranty Program for Money Market Funds

September 19, 2008
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Treasury Announces Guaranty Program for Money Market Funds

Washington

- The U.S. Treasury Department today announced the establishment of a temporary guaranty program for the U.S. money market mutual fund industry. For the next year, the U.S. Treasury will insure the holdings of any publicly offered eligible money market mutual fund – both retail and institutional – that pays a fee to participate in the program.

President George W. Bush approved the use of existing authorities by Secretary Henry M. Paulson, Jr. to make available as necessary the assets of the Exchange Stabilization Fund for up to $50 billion to guarantee the payment in the circumstances described below.

Money market funds play an important role as a savings and investment vehicle for many Americans; they are also a fundamental source of financing for our capital markets and financial institutions. Maintaining confidence in the money market fund industry is critical to protecting the integrity and stability of the global financial system.

Concerns about the net asset value of money market funds falling below $1 have exacerbated global financial market turmoil and caused severe liquidity strains in world markets. In turn, these pressures have caused a spike in some short term interest and funding rates, and significantly heightened volatility in exchange markets. Absent the provision of such financing, there is a substantial risk of further heightened global instability.

Maintenance of the standard $1 net asset value for money market mutual funds is important to investors. If the net asset value for a fund falls below $1, this undermines investor confidence. The program provides support to investors in funds that participate in the program and those funds will not "break the buck".

This action should enhance market confidence and alleviate investors' concerns about the ability for money market mutual funds to absorb a loss. Investors in money market mutual funds with a net asset value that falls below $1 would be notified that their fund triggered the insurance program.

The Exchange Stabilization Fund was established by the Gold Reserve Act of 1934. This Act authorizes the Secretary of the Treasury, with the approval of the President, "to deal in gold, foreign exchange, and other instruments of credit and securities" consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. More information on the Exchange Stabilization Fund can be found at http://www.treas.gov/offices/international-affairs/esf/.

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Paulson Statement on Comprehensive Approach to Market Developments

September 19, 2008
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Statement by Secretary Henry M. Paulson, Jr. on Comprehensive Approach to Market Developments

Washington, DC--

Last night, Federal Reserve Chairman Ben Bernanke, SEC Chairman Chris Cox and I had a lengthy and productive working session with Congressional leaders. We began a substantive discussion on the need for a comprehensive approach to relieving the stresses on our financial institutions and markets.

We have acted on a case-by-case basis in recent weeks, addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner. And this morning we've taken a number of powerful tactical steps to increase confidence in the system, including the establishment of a temporary guaranty program for the U.S. money market mutual fund industry.

Despite these steps, more is needed. We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses.

The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy. When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy.

As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing. This simply put too many families into mortgages they could not afford. We are seeing the impact on homeowners and neighborhoods, with 5 million homeowners now delinquent or in foreclosure. What began as a sub-prime lending problem has spread to other, less-risky mortgages, and contributed to excess home inventories that have pushed down home prices for responsible homeowners.

A similar scenario is playing out among the lenders who made those mortgages, the securitizers who bought, repackaged and resold them, and the investors who bought them. These troubled loans are now parked, or frozen, on the balance sheets of banks and other financial institutions, preventing them from financing productive loans. The inability to determine their worth has fostered uncertainty about mortgage assets, and even about the financial condition of the institutions that own them. The normal buying and selling of nearly all types of mortgage assets has become challenged.

These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans' personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.

To restore confidence in our markets and our financial institutions, so they can fuel continued growth and prosperity, we must address the underlying problem.

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.

I believe many Members of Congress share my conviction. I will spend the weekend working with members of Congress of both parties to examine approaches to alleviate the pressure of these bad loans on our system, so credit can flow once again to American consumers and companies. Our economic health requires that we work together for prompt, bipartisan action.

As we work with the Congress to pass this legislation over the next week, other immediate actions will provide relief.

First, to provide critical additional funding to our mortgage markets, the GSEs Fannie Mae and Freddie Mac will increase their purchases of mortgage-backed securities (MBS). These two enterprises must carry out their mission to support the mortgage market.

Second, to increase the availability of capital for new home loans, Treasury will expand the MBS purchase program we announced earlier this month. This will complement the capital provided by the GSEs and will help facilitate mortgage availability and affordability.

These two steps will provide some initial support to mortgage assets, but they are not enough. Many of the illiquid assets clogging our system today do not meet the regulatory requirements to be eligible for purchase by the GSEs or by the Treasury program.

I look forward to working with Congress to pass necessary legislation to remove these troubled assets from our financial system. When we get through this difficult period, which we will, our next task must be to improve the financial regulatory structure so that these past excesses do not recur. This crisis demonstrates in vivid terms that our financial regulatory structure is sub-optimal, duplicative and outdated. I have put forward my ideas for a modernized financial oversight structure that matches our modern economy, and more closely links the regulatory structure to the reasons why we regulate. That is a critical debate for another day.

Right now, our focus is restoring the strength of our financial system so it can again finance economic growth. The financial security of all Americans – their retirement savings, their home values, their ability to borrow for college, and the opportunities for more and higher-paying jobs – depends on our ability to restore our financial institutions to a sound footing.



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What Happens If There Is A Run On Money Markets? Is There A "Money Market Mutual Fund Holiday" Ahead?

News that the  Reserve Primary Fund, the oldest mutual fund in the country with $64 billion under management, has broken the buck and frozen resumptions for 7 days, is not good.

Edges of panic are beginning to appear throughout the system. There is a flight to absolute safety. 3-month T-Bills are trading to yield 0.558% ( yield not seen since 1954!).  Gold, as I write, is up over $88.50.

Clearly, gold and Treasury bills are the only safe havens in investors eyes. If another money market mutual fund freezes redemptions, all out panic could ensue. How exactly does the government stop that panic? The possibility of freezing all money market funds in a "money market mutual fund holiday," à la the Great Depressiom "Bank Holidays", can not be ruled out. The Fed and Treasury would then buy themselves some time to pump money into the entire money market mutual fund system, somehow.

Pray it doesn't come to this, but if money market mutual fund redemptions begin to soar, I see no alternative.

-Robert Wenzel 

Treasury Announces Supplementary Financing Program

All these bailouts are forcing the Treasury to borrow and borrow. Will the Fed print money to buy the new Treasury securities? This press release from the Treasury seems to imply that:

September 17, 2008
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Treasury Announces Supplementary Financing Program

Washington

The Federal Reserve has announced a series of lending and liquidity initiatives during the past several quarters intended to address heightened liquidity pressures in the financial market, including enhancing its liquidity facilities this week. To manage the balance sheet impact of these efforts, the Federal Reserve has taken a number of actions, including redeeming and selling securities from the System Open Market Account portfolio.

The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives.

Announcements of and participation in auctions conducted under the Supplementary Financing Program will be governed by existing Treasury auction rules. Treasury will provide as much advance notification as possible regarding the timing, size, and maturity of any bills auctioned for Supplementary Financing Program purposes.

-Robert Wenzel

Bulletin: U.S. Government Assisting in Sale of Lehman Brothers

David Cho and Heather Landy of the Washington Post are reporting that the Treasury Department and the Federal Reserve are helping Lehman Brothers put itself up for sale. The details are not finalized, but sources familiar with the matter say the purchase is expected to be completed and announced this weekend before Asian markets open Monday morning.

The Fed and Treasury are talking to a wide range of firms and examining multiple scenarios for the sale of the investment broker, according to WaPo.

-EPJ Newsdesk

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
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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