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FEDS BAIL OUT FANNIE AND FREDDIE; EMERGENCY MEASURES TAKEN

by Charles Feldman on July 13, 2008 · 6 comments

  

In a clear sign the federal government is far more concerned about the financial health of mortgage finance giants Fannie Mae and Freddie Mac than its public comments indicated as late as Friday, the U.S. government Sunday night announced what some are calling a “massive aid” package to the two shareholder owned and run companies officially cementing a government relationship that till now was only implied but never admitted to.
According to a Reuters dispatch, the plan, which will require swift approval from Congress, is designed to “head off a potential meltdown in financial markets.”

Here’s what the government is offering Fannie and Freddie:

  1. Access to its emergency cash–the so-called discount window
  2. A huge “temporary” increase in the line of credit available
  3. The U.S. Treasury will, for the first time ever, purchase equity in both companies should it be needed
  4. Investigation by the Securities and Exchange Commission to stop the spread of “false information.”

Both Fannie and Freddie are vital to the housing market–they buy mortgages from banks and other lenders and either keep them or repackage them into securities that are sold to investors.

“Welcome to the socialist state”

Strong words from some critics are already greeting the government plan. Josh Rosner, the managing director at Graham Fisher in New York told Reuters, “It’s outrageous. It’s offensive. Welcome to the socialist state. In capitalism, winners are supposed to reap rewards and losers are supposed to take losses for bad risk management. These are private companies.”

But others are deeply concerned that should Fannie and Freddie fail–though they both say they are well capitalized–the shockwaves would cause a financial meltdown world-wide.

The most troubling part of the government plan,perhaps, is the possibility the Treasury might buy equity in Fannie and Freddie. Some critics charge this could end up costing taxpayers enormous sums of money.

It will be interesting to see whether Wall Street gives the plan a thumbs up or thumbs down during Monday’s trading.

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{ 6 comments… read them below or add one }

Brock July 14, 2008 at 5:31 am

Just a couple thoughts:

1. Freddie & Fannie are too big, and the government has allowed them to be implicitly guaranteed too long. That should never have happened. They should have been broken up into smaller companies and the Fed should have made it abundantly clear that no special treatment would be available.

But while true, the above is water under the bridge. It can’t be fixed now. It should have been fixed years ago, but no recent Congress or Administration has shown that kind of foresight or leadership.

2. A bailout is “money without payback.” It’s just a check. The above is either a loan or a equity dilution. Loans have to be paid back. Equity, once diluted, must be purchased back to regain equity.

One must presume that the Fed would unload any equity position into the market once the crisis has passed. It’s not a perfect solution, but none of the good choices are available to us now.

Reply

Brock July 14, 2008 at 5:32 am

Oh, my point with #1 was that Fannie and Freddie have always been socialists masquerading as capitalists. So, no change, really, it’s just that the mask has slipped.

Reply

Colin - Buying Florida Property July 14, 2008 at 6:44 am

I agree with Brock’s points – and anything so large is difficult for the private sector to control efficiently, let alone big government. At the time of writing, the Dow Jones reaction seems to indicate initial relief in the markets, so maybe the businesses can be broken up when things settle down.

Reply

Joshua Dorkin July 14, 2008 at 8:17 am

The market reaction so far is definitely much better then I expected. Lets see how things progress as we go forward.

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Doug Cox July 14, 2008 at 8:35 am

Look at the insider shares sold off in Jan 2008 –over $4.2 million by directors. Now we’re bailing THEM out???

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Cliff Pape July 15, 2008 at 6:49 pm

As an economist it would be nice to let markets take care of themselves. However, with regards to Freddie and Fannie tough love would be dumb love. People who promote the government not stepping in to help Freddie and Fannie really do not understand global financial markets. Anyone who understands global financial markets is pushing the federal government to step in and stay the course to ensure we do not have a global financial market crisis.

A side note would be for real estate investors. It would behoove any real estate investor to research the Savings and Loan crisis of the 1980’s. The government is taking similar actions as it did then. The bailout is a bailout because everyone realizes that the securities that the government will be purchasing in exchange to fund banks will virtually be worthless. Just like they where in the Bear Stearns deal. So the government buys assets they ultimately know will fail. Once the assets (i.e. government owned real estate) fail they will be auctioned off at substantial discounts. What all this means is that savvy investors stand to make millions on the soon to come government bail out(s).

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