by Damozel | John Cole of Balloon Juice:
Phil Graham was right. The whiners are everywhere:
Deb Cupples posted yesterday about the impending rescue.While we wait for the unveiling of the plan, there was much speculation and uneasiness about what this plan would mean.
Barney Frank (D-Mass), Chairman of the House Financial Services Committee, announced that Treasury Secretary Henry Paulson ""intends to use the powers that Congress provided...." in a law passed in July to keep Fannie Mae and Freddie Mac stable and functioning." (WSJ) Frank didn't know the details, but The Wall Street Journal stated that the Treasury Department was "putting the finishing touches" on its plan.(WSJ)
The Washington Post says that this bailout has all the disadvantages of the previous one and would represent "a major escalation in government private lending." (WaPo)
Under the plan, which could prompt one of the most sweeping government interventions in financial markets in U.S. history, federal officials would place the firms under a conservatorship, a legal status giving the government the option and time to restructure and revive the companies, the sources said. The value of the companies' common stock would be diluted but not wiped out, while the holdings of other securities, including company debt and preferred shares might be protected by the government.
Instead of giving each company a big capital infusion upfront, the government could make quarterly injections as the companies' losses warrant, the sources said. This would be an attempt to minimize the initial cost of the rescue.
Who benefits directly from this massive intervention? Here's what WaPo said earlier---a report which later reports seems to contradict.
It has been unclear which investors, if any, would suffer should the government intervene to prop up the firms.
The answer, in [Treasury Secretary Henry M.] Paulson's plan, is that holders of preferred shares and subordinated debt, a riskier but higher-paying class of debt, might be made whole. Government leaders were reluctant to allow holders of those assets to incur major losses because they are widely held by banks, and major losses could cause a wave of bank failures.
At Angry Bear, Ken Houghton sums up the consequences if the preferred shares were to be made whole.
So who are the major individual holders of the stock? Why, the directors of the company, the five of whom listed hold over 2.1 million shares.
That is, the same people who were tasked with ensuring that the company was well run—and have failed miserably at it—are being saved by the form of the bailout, while the cost—again, judging by the lessons of the slow-motion S&L meltdown—will be increasing for the taxpayers.
The next time someone asks me if I believe in "free-market capitalism," I'm going to ask if they believe in the Easter Bunny. (Angry Bear)
Here at BN-Politics, Deb Cupples expressed similar sentiments.
But an update from Naked Capitalism suggests that the result might well be otherwise and that the preferred holders might "take big hits."
The stunner, which contradicts preliminary reports, is that the preferred shareholders in the GSEs will take losses. The Wall Street Journal reports that dividends on common will be eliminated and those on preferred will be suspended (Bloomberg, Reuters, and the New York Times were less specific, but indicated that preferred shareholders would suffer).
(Via Naked Capitalism) Justin Fox at Time provides some insight into the consequences:
When the Federal Deposit Insurance Corp. takes over a failing bank, shareholders are usually wiped out, insured depositors are made whole, and everybody else (creditors, uninsured depositors, etc.) has to divide whatever money is left.
Holders of the mortgage-backed securities issued by Fannie and Freddie are pretty much equivalent to insured depositors. The MBSes aren't officially insured or guaranteed by the government, but buyers have long assumed that they were. Even critics of the two firms agree that it would be disastrous if Treasury allowed the MBSes to default.
But what about the shareholders? It seems only fair that if the government has to step in to take over the companies, shareholders should lose everything. Except that there's a big complication: Lots of small and mid-sized banks in the U.S. have, with encouragement from regulators, built up big holdings in Fannie and Freddie preferred stock, which they use to satisfy their capital requirements. If Fannie and Freddie preferred shares become worthless, a lot of banks will become insolvent. Which, with the FDIC insurance fund already being depleted by bank failure, could end up costing taxpayers a ton.
Fox wondered how Secretary Paulson could come up with a plan that would resolve all these conflicting interests. I guess we're soon going to find out.
In the meantime, it's interesting to consider the broader implications of the government's intervention.
At Open Left, Chris Bowers asked how the government's actions in taking on Freddie and Fannie differs from nationalization.
I'm not versed enough in economics to know if this technically qualifies as the nationalization of a major financial sector, but it sure sounds like it:...
...[T]he move to nationalize the mortgage industry...actually seems like a good idea to me. The problem I have is with the incredible cognitive dissonance surrounding "big government" in our national political discourse. Even as we have reached national consensus on nationalizing industries, which is the literal definition of socialism and big government, politicians of every party keep talking about "small government" as though it were a virtue. I mean, the day after the Republican convention, which included countless attacks on big government, the Republican administration goes out an nationalizes a major industry. It will probably be done in the corporate welfare style typical of American government--privatize the profits, socialize the risk--but it is still nationalization....
Can we all stop lying to ourselves on this one? Please? Pretty please? This national self-delusion is a major obstacle to having an honest ideological debate in this country.
Economist Brad DeLong considers Bowers' question whether what we're seeing is nationalization. : According to DeLong, (1) most people "with a clue" "has long agreed that the short-term money market---the supply and demand of liquid assets---has to be a government-controlled market rather than a free market; and (2) Secretary Paulson wants that sort of treatment for "the long-term finance market for housing.". (Grasping Reality) DeLong says he needs to think further about the issue, but doesn't see any immediate necessity for nationalizing Freddie and Fannie for reasons stated here.
I take it from this that he agrees with Bowers that what we are seeing is, or at least may be, a move towards nationalizing Freddie and Fannie or something closely resembling it.
According to The New York Times, Josh Rosner (an analyst at a New York independent research firm) said, “We have just had to nationalize the two largest financial institutions in the world because of policy makers’ inaction....Since 2003, when these companies’ accounting came under question, policy makers have done nothing.”
Possibly. At present, the government's control is intended to be, or presented as, only temporary:
The plan is expected to involve putting the two companies into the conservatorship of their regulator, the Federal Housing Finance Agency, said several people familiar with the matter. That would mean the government would take the reins of the companies, at least temporarily.(WSJ)
However Barney Frank concedes that continuing to have them run by the government (i.e., nationalization) is under discussion:
The government is expected to control the two companies at least a year as it evaluates and debates whether Fannie and Freddie should remain government-run entities or be restructured in some fashion, Frank said in an interview. (HuffPost)
The New York Times explains conservatorship as follows:
A conservatorship would operate much like a pre-packaged bankruptcy, similar to what smaller companies use to clean up their books and then emerge with stronger balance sheets. It would allow for uninterrupted operation of the companies, crucial players in the diminished mortgage market, where they are now responsible for nearly 70 percent of new loans.
Sounds like just what the doctor ordered. But of course, giving them an infusion or transfusion of capital is going to cost money.
[The Conservatorship] is expected to involve the government injecting capital into Fannie and Freddie. That could happen gradually on a quarter-by-quarter basis, rather than in a single move, one person familiar with the matter said.(WSJ)
At any rate, it's pretty clear who is going to be paying the price for getting Freddie and Fannie out of trouble.
In July, Congress passed a plan to provide unlimited government loans to Fannie and Freddie and to purchase stock in the companies if needed. Critics say the open-ended nature of the rescue package could expose taxpayers to billions of dollars of potential losses. (HuffPost)
With respect to the "injections" of capital, Hale "Bonddad" Stewart remarks: "Considering these organizations own or guarantee $5 trillion in mortgages, we could be in for a bumpy ride...Here's the short version: The US taxpayer is now on the hook for the housing mess."
At The L.A. Times, Peter Gosselin says that the conservatorship decision doesn't mean that Secretary Paulson has agreed to a big injection of taxpayer money. (LAT) I guess we'll see, won't we?
As to the ultimate fate of the companies, WaPo suggests:
Placing the companies in conservatorship, rather than receivership, could signal that the government does not intend to nationalize or liquidate Fannie Mae and Freddie Mac. Instead, under the terms of a federal law passed this summer, conservatorship is designed to allow the government to restructure the companies and return them to private control.
The current "epic decision" underscores just how dire the situation has become and is just one more mess that the next administration is going to have to clean up. At least, as Stewart says at HuffPost, "they're firing the executives who got the companies into this mess. "[I]t's about time. These idiots got the companies into the mess; there is no need to keep them around."
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