Wednesday, September 10, 2008

Details revealed about Freddy Mac and Fannie Mae’s taxpayer-funded bailouts

If you should be fortunate enough to have a little free time on your hands this week - and you find yourself anxious to gain a better-informed perspective on global affairs, be sure to read this exclusive report in the New York Times. It discusses the financial future of the two quasi-governmental mortgage agencies Freddy Mac and Fannie Mae. It was written by veteran NYT financial journalist Andrew Ross Sorkin (who also compiles the NYT's online database of merger and acquisition activity DealBook.

From Sorkin's reporting:

According to Treasury Secretary Henry M. Paulson Jr., he informed a Congressional panel in July about his plans to stabilize Fannie Mae and Freddie Mac and, with them, the financial markets as well as “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”

The bazooka in question was his new authority to seize the two mortgage finance giants if things went horribly wrong. The thinking was, if the markets knew that Mr. Paulson was packing heat, the markets would back off and confidence would be restored. He might save Fannie and Freddie without firing a shot — sort of a Wall Street version of the theory of deterrence.

And yet the moment Mr. Paulson uttered that line, it was all over for Fannie and Freddie. Once he mentioned that bazooka — that is, the possibility that the Bush administration might take over the two companies — he virtually guaranteed that that was exactly what would happen. On Sunday, his bazooka went off, and the shot is still reverberating around the world.

The rest was just theater. For the last two months, Fannie and Freddie ran around Wall Street searching for a savior. Private equity? Sovereign wealth funds? Anyone?

But Wall Street was never really sure what Mr. Paulson would do — and that was a problem. “He never laid out a roadmap and how he would use the power. Because of the uncertainty nobody was willing to put in money” into Fannie or Freddie, said Doug A. Dachille, the chief executive of First Principles Capital Management.

The companies also never got the chance to tap people who already owned their stock for additional cash. “We will never know whether existing shareholders would have put in money,” Mr. Dachille said.
Meanwhile, the companies’ bankers — Goldman Sachs, JPMorgan Chase and others — jockeyed for positions of influence, and yes, fees. (Morgan Stanley, which had been working for Freddie — and was at one point demoted, according to company executives — jumped ship and found a more prestigious, pro bono role advising Mr. Paulson and the government.)

But the real question is, did things have to end this way? The answer, many on Wall Street believe, is yes. But maybe not when nor the way it did.

Many people in financial circles can’t quite figure out why Mr. Paulson, the former chairman of Goldman Sachs, pulled the trigger when he did. He insisted politics had nothing to do with it. Never mind that the news broke just after the Democratic and Republican conventions, but as far away as possible from the November election.

But as of last week, Fannie and Freddie, for all their troubles, seemed to be bumbling along O.K. Both were able to roll over their enormous debts in the capital markets. Sure, Wall Street was nervous about those debt auctions, but the sales were running efficiently, in part because Mr. Paulson’s promise — or threat, depending on your view — showed that the government would stand behind the companies in the end.

What’s more, Fannie had made good on its promise to raise $5.5 billion last spring, before Mr. Paulson asked Congress for his bazooka. By most analysts’ accounts, Fannie had enough wiggle room to stay in business for a while longer, if not find a way out of the mess down the road.

“We are surprised that such measures are deemed necessary at this time,” Bradley Ball, a research analyst at Citigroup, wrote in a research report on Sunday night.

Freddie — long considered the more troubled of the two — was capitalized enough to keep going through 2009, many analysts believe. “Even if neither raises another dollar of capital over the next year, we estimate that both companies will likely remain above their statutory minimum requirements,” Bruce W. Harting, an analyst at Lehman Brothers wrote.

Neither company is blameless. Freddie seemingly refused to raise new money while it still could, in part, for fear of diluting its shareholders and selling too low. Freddie was convinced it could recover first; the power of optimism is a dangerous force. Indeed, it was Freddie’s balance sheet that had Mr. Paulson most worried, at least in the immediate term.

Could Mr. Paulson have put Freddie into a conservatorship without bringing Fannie in too? Probably not. It would have just put more pressure on Fannie.

In the end, Mr. Paulson’s decision seems to have been a philosophical one, rather than one forced by imminent crisis. Of course, for stagecraft purposes, it was played as impending disaster.

His decision will either go down as a masterstroke of genius — or as a horrible lapse of judgement that future generations of American taxpayers will get stuck paying off..

[Paulson] appeared to want to take care of the problem himself — perhaps guaranteeing him a lasting legacy — during his time in the Bush administration. This way, had either Fannie or Freddie run into problems in the next administration, nobody could point the finger at him. For that reason, perhaps we should give credit to Mr. Paulson for jumping in ahead of more problems instead of looking back and playing Washington’s blame game after the fact.

There’s something very Wall Street about the decision: firms often write down their bad investments in one year, so they can start the next year fresh.

All of us will bear the cost, of course. The scariest part of Mr. Paulson’s economic acrobatics is that we won’t know for years just how much this will cost us. On CNBC on Monday morning, when asked about how big the bill might be, Mr. Paulson replied, “We didn’t sit there and figure this out with a calculator.” Apparently, he wasn’t joking.

For an example, check out this excerpt from an article by William Greider from The Nation's blog "The Notion":
The 2008 election has many unusual aspects, but none is more bizarre than the sorry spectacle of the bailout for Fannie Mae and Freddie Mac.

American voters are like the lambs being led to slaughter and at the very height of the presidential campaign. Yet not a peep of protest from John McCain and Barack Obama, not even a hint of the righteous anger injured taxpayers will rightly feel as they figure out the deal for themselves. The rescue of the two giant mortgage firms is another huge expenditure of the public's money--one or two hundred billion dollars this time--to reassure bankers and financiers the government stands by them in their troubles, whatever the costs.

Think about it. Candidates Obama and McCain are wagging their fingers at the governing system in Washington, both warning they intend to make big changes if elected. Meanwhile, business-as-usual doesn't wait for the next president. The financial system needs the capital right now, and so Treasury Secretary Henry Paulson has opened up the spigot. Obama and McCain meekly bless the deal. This sequence of events makes them look look the political goats, their grand talk of change pushed aside by what Wall Street demands.

The 2008 election may be close, but it looks like the status quo has already won.

There is a lot more pain and embarrassment to come. The nation is in the midst of an historic financial crisis--more bank failures are ahead and probably another bailout of even larger scale. Yet the two major parties act as though this subject is too complicated for ordinary Americans to understand. Neither candidate has found the nerve (or decency) to explain the full dimensions of what the country is facing. Both men are no doubt told to say as little as possible, for fear of touching off more panic among investors. Voters can safely be left in the dark.

Facing the crisis honestly would not fit very well with the flag-waving campaign themes. The United States is financially busted and utterly dependent on lending from foreign powers--both friends and rivals around the world. The government rescue of Fannie Mae and Freddie Mac could not be put off until after the election, as insiders had hoped, because foreign creditors were beginning to back away from lending any more capital to the two failing US firms. The major creditors are led by China, Japan and other Asian nations, plus oil-rich Arab states and even Russia. The Bank of China has reduced its $376 billion in lending to Fannie and Freddie by 25 percent since July and other nations threaten to do the same.

So the Treasury arranged a deal that throws Fannie and Freddie shareholders over the side, but promises to protect the creditors, foreign and domestic. Bill Gross, chief investment officer of PIMCO, the mammoth bond house in California, issued an ominous warning in advance. If Washington didn't "open up the balance sheet of the US Treasury" and pump lots of public money into the ailing financial firms, the major lenders would sit by and let the great deflation of Wall Street proceed to its ruinous climax. Without the big lenders, credit would dry up through the US economy and the destruction could prove bloody historic for all. The Treasury Secretary heard the message.

How much more capital does Wall Street need to get well? Maybe as much as $500 billion, some experts estimate. What's frightening is that even that great amount might not provide a cure for anytime soon for the real economy, where unemployment rises along with mortgage foreclosures. Thus, Washington puts up unlimited billions for financial repair, but has been rather penny-pinching about paying for economic stimulus aimed at work and production. Obama now proposes a new stimulus package, but the pitiful sum of $50 billion. McCain talks up more corporate tax cuts.

If Americans had a functioning democracy, both of these guys would be competing furiously to get real.


Gail said...

Love the new look of your blog...I have been forwarding the site to everyone I know...Wonderful research, insight and commentary....Gail

Jim Rohner said...

This is quite a hectic time to be a tax payer. The ever increasing national debt will certainly be a hot button issue for the upcoming presidential election and people NEED to be educated about the issue.

"I.O.U.S.A." is a recently released documentary that deals with the risks of our nation's debt and is being revered as one of the most important films of the year. To listen to a podcast interview with director Patrick Creadon, head over to Zoom In Online. Creadon is joined by U.S. Comptroller General David Walker and other guests in this interview originally recorded after the film's premiere at the 2008 Sundance Film Festival.

Joe B said...

As Nikolai Gogol observed all those years ago, "If there's a gun hanging on the wall in the first act, it has to go off in the last act." Same seems to hold true of bazookas.

A half-trillion dollars is an interesting number. Roughly equal to spending in Iraq, where administration supporters (such as may be found) tell us that US "investment" is making life better for Iraqi civilians.

An equal investment in the US economy (minus the blood) would be a true masterstroke. Time to shift spending.

Nicole said...

While there are certainly many grounds to be concerned about the country’s economic condition, the view presented in IOUSA is one-sided and misleading. CEPR’s analysis [] puts many of the issues raised in the movie in a broader context and features a minute-by-minute viewer’s guide of inaccurate or misleading statements in the film. It is important that the public be well informed about economic issues and not allow itself to be railroaded into ill-considered policy choices.