Sunday, September 7, 2008

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.

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