I've been following this for weeks in The Economist. They recommended that the Fed do this, but I honestly didn't think it would happen. Here are a couple recent articles if ou haven't been following:
Since Jim Collins (Built to Last, Good to Great) has come up a few times here, just thought I'd mention that Fannie Mae is one of his "Good to Great" companies.
The Halo Effect, by Phil Rosenzweig, does a good job describing many of the problems with popular business books like Good to Great and In Search of Excellence. It's worth reading.
Has the leadership of Fannie Mae changed since Collins did his analysis? If it has, then this might not be a counterexample. I don't think he said that companies can't go from good to great to suckage.
If the people leading the company are the same, though, then it would seem to contradict his theory, which (as I recall) places the greatest emphasis on that factor.
A bailout has been rumored for quite some time. There have been a couple instances in the past few months where news outlets have reported that a weekend deal is imminent, but nothing ever came. The mortgage basis (i.e. the difference in yield between mortgage-backed bonds guaranteed by Fannie/Freddie and Treasury notes) has compressed quite a bit in recent weeks, indicating a lower expectation of risk because market participants have been expecting a deal. But yesterday when the news hit, mortgages didn't really do much... we sold off a couple ticks and the basis tightened by 2 basis points or so, but that was it.
In short, the bond market won't treat this as news until some concrete announcement comes out -- it's already been priced in. It's only the common equity holders who are reacting, since any deal will likely wipe them out.
I have come to have a term for these announcements of action to take over banks, restructure credit, etc. which always seem to happen on Friday afternoons, timed perfectly to have minimal impact on the news cycle and get the least amount of attention.
The U.S. mortgage system works like this: Freddie Mac and Fannie Mae make the housing market more liquid by buying up mortgage loans satisfying reasonable criteria. Other banks can issue mortgages and then immediately resell the loans back to Fannie and Freddie. This makes it easy to get a mortgage through any bank if you have a reasonable financial history, because the other banks don't have to serve out the loans they issue.
Since Fannie and Freddie were implicitly backed by the Fed, they were able to leverage their capital much more than a normal bank in taking on loans -- only a few percent of their issued loans were backed up by real money. These beasts were designed to be too big to fail, and in the unlikely event that they did fail, the companies' histories indicated that the Fed would step in. This is a huge advantage for the two companies, and over the years they essentially squeezed other banks out of the prime mortgage market.
The entire housing market therefore depends on the ability of Fannie and Freddie to buy up the mortgage loans that other banks issue. Without them, the pool of available capital to support those loans would suddenly shrink dramatically, meaning much fewer loans can be issued. Meaning none of us could buy a house for the next few years.
The Fed is stepping in because (1) they created both companies originally, though they cut the umbilical cord at some point; (2) they're still tied into the companies' finances in various ways; and (3) crippling the housing market and setting off a chain reaction of more bank collapses is not something this economy needs, particularly in an election year. There are a few other government-sponsored enterprises that would also get this sort of rescue if needed. Boeing isn't one of them, but as a matter of national security, I doubt the government would allow them to fail. (I still can't quite explain why Bear Stearns got bailed out, but they did.)
The prospectus for every bond issued by these agencies explicitly states that it is not guaranteed by the United States.
The housing market does not need Fannie and Freddie. What it needs is a stable provider of liquidity (a broker for the secondary mortgage market). Let Fannie and Freddie fail, and simultaneously introduce an explicitly-backstopped liquidity mechanism/agency.
While this sounds good in theory, I get the feeling this is one of those easier-said-than-done situations. Even if there was a replacement liquidity provider ready to replace the two firms, letting them fail would cause a huge amount of stress for the market.
True. It's unclear exactly how the federal government "implicitly" backed Fannie and Freddie, besides occasional congressional meddling and the companies' history as GSEs, but other financial agencies and investors treated them as if they knew the government would step in if there was a problem -- and it turns out they were right.
An extremely oversimplified answer is that it would hurt confidence in the dollar, which would further damage its status as the foreign federal reserve currency, which would cause further inflation in the US.
When foreign federal reserves switch their reserve stash from dollars to something else, the dollars are basically "created" on the market as one currency becomes instantly less available and the other instantly more available.
Right! If our economy relies so much on housing to the point that it is a threat to the entire economy, then it shows that we didn't have a solid economy in the first place.
We are seriously compromising the well-being of future generations of this country in order to bail-out over-consuming house-owners and fat-cats in Wall Street. Absolutely outrageous.
No, I can't say, because it wasn't necessary. We're all looking at Paulson's right hand waving about conservatorship, but missing his left hand; his left hand is bailing out the foreign central banks who bought agency paper and later threatened to dump treasury paper if their agency paper was not backstopped. So now the shareholders get hosed but the foreign central banks get their bonds paid for by the American taxpayers.
the foreign central banks get their bonds paid for by the American taxpayers.
Given that the bonds are backed by mortgages taken out by those very same American taxpayers, it doesn't seem all that unfair. (And all those T-bills, as well as the mortgage bonds, were bought by dollars paid to overseas businesses to buy lots of cheap goods for American consumers).
> After stock markets closed on Friday, the shares of Fannie and Freddie plummeted. Fannie was trading around $5.50, down from $70 a year ago. Freddie was trading at about $4, down from about $65 a year ago.
It looks like a good time to buy Fannie & Freddie stock!
In other words, unscrupulous investment bankers might see an opportunity in helping weaker banks launching covered bonds; given their circumstances, these banks will have to provide top notch collateral, ie their best remaining assets, and will probably not get a great price for them (ie the bonds will be both overcollateralised and expensive).
Either the offered price is less than what these assets could otherwise be sold for (i.e. the transaction won't happen) or it's more (in which case the price criticism doesn't make sense).
Other than that, decent but fear-mongering article. Pretty much any scheme by which you exchange cash for a set of promised future cash payments is bound to be abused at some point. There is very little new here, except that this is another quasi-guaranteed asset.
It's about time they work out a plan to move forward and add some stability to these two companies and the market. I don't like the idea of having the taxpayers foot the bill for all of this mess, but the alternative is even worse (doing nothing and letting the market continue to its downward trend). I would imagine that in this day and age the majority of people have some, if not all, of their retirement money in the stock market either through 401ks or through private brokerage firms. Either way the the common American gets to pay for this mess - through depressed stock prices or through taxes used to bail out Freddy, Fannie, and others like them.
It's got to suck for anyone how owned shares of either of these two firms. Down something like 80% this year. Ouch!
Well, now that they have been nationalized, it's more like 100%. From my understanding (as gleaned from the Economist), this will wipe out shareholders, both common and preferred.
But either way, I think the Feds are doing a good thing, as these guys were pulling Enron-style shenanigans, (guaranteeing their own mortgages, etc) and dominating the conforming mortgage market due to their access to cheap debt. Let regular banks step in and serve that market, instead of being confined to riskier mortgages that the two giants weren't allowed to buy.
Not really. Both were chartered by Congress, and at best are considered quasi-private. This position (being quasi-private) may actually be worse than either totally private or totally public, but in any case isn't anything close to unfettered capitalism.
I'm going to put a premature stop to this by beating everyone to the punchline.
Libertarians: "It's always, everywhere, every time the government's fault. If the government would just get out of the way, everything would be roses and flowers in Libertopia".
Left-wingers: "You're on crack. This whole thing happened because we need more government regulation. If we could just get good regulations and put the people in power over greedy multi-national globalized corporate ... (and so on) ... we would be much better off!".
Real-worlders: "Libertopia is about as likely to work as Marxistan, the system we have is pretty good, but will always need some tweaking. There is plenty of scope for debate, on a case by case basis, looking at the actual facts and data for each case. Sometimes we should tack away from regulations, in other cases some government intervention might work to improve markets. In this case, Fannie Mae and Freddy Mac were probably not that good an idea to begin with. Oh, and by the way, these sorts of debates probably don't belong on Hacker News;-)"
Oh, and by the way, "wholesale indictment of American capitalism" is just handwaving. "American capitalism" is an awfully broad range of things, from Joe's Corner Sandwich Shop to Goldman Sachs to, well, Y Combinator.
Pigeonholing commenters is kind of patronizing, isn't it? Those general arguments, in the right context and with the right facts, can all be reasonably made.
"The right context" is over a bottle of good wine, an offer open to anyone who happens by the same corner of the world I happen to be in. I didn't mean to be patronizing; there are smart people I respect that take those views, merely to 'head them off at the pass'.
You have no idea what you're talking about. Both groups had board appointees from the government. The market basically assumed they were "too big to fail", meaning if trouble happened, the government would take over.
When a company isn't run by it's shareholders and beholden to the market, bad things happen. Many of the choices made by both groups wouldn't have made it had there been better oversight.
Government involvement was the problem here, not capitalism.
Recent background article:
http://www.economist.com/finance/displaystory.cfm?story_id=1...
about nationalisation:
http://www.economist.com/opinion/displaystory.cfm?story_id=1....