THE RECENT BAIL-OUT OF FANNIE MAE & FREDDIE MAC

Draw your own conclusions from this video.

The first part shows the interim CEO of Fannie Mae speaking in front of the Congressional Black Caucus (CBC). The speech was delivered in 2005, the year that the housing bubble peaked. It's interesting to hear the CEO admit the existence of serious problems already brewing inside Fannie Mae.

It's followed by a Fox News commentary and analysis that explains the relationship of the CBC to Fannie Mae. It also reveals Senator Obama's role in the Congressional Black Caucus.

At the end of this post, is a copy of the article that appeared in the website of Washington State's Herald newspaper. (I do this to minimize the frustration of clicking on a dead link.)

The article explains the significance of this two quasi-government institutions and why they had to be bailed out.

FANNIE MAC, FREDDIE MAC BAILOUT HAD TO HAPPEN
Published Sunday, September 14, 2008 by James McCusker

The story was that Fannie Mae and Freddie Mac had no choice. They would either agree to a federal government takeover or, alternatively, the federal government would take over anyway.

The back story, though, is that the Treasury Department didn't have a choice, either.

Two factors forced the decision to take over the mortgage giants. The first was that a review of Freddie Mac's books revealed that its accounting methods had overstated its capital position. When this information was made public the financial markets would again be in turmoil, something the Treasury Department neither needed nor wanted.

The significance of the accounting issue should not be understated.

Both Freddie Mac and Fannie Mae had made a point of their capital adequacy as each presented its best face to the markets and the public. And, in fact, both of the mortgage giants appeared to have capital levels that not only met but also exceeded regulatory requirements.

If the capital accounts were built on sand, though, lenders and investors would feel that they had been deceived. A reputation for deception is not a good thing to have in financial markets. And an accounting mess is certainly not a good thing to reveal while the Treasury Department was inside these organizations and backing them up. Its reputation would be smeared, too.

We should not underestimate the importance of human nature, either. Almost certainly Freddie Mac's accounting made the feds wonder, "What are we going to find next?"

Financial markets do not like the unexpected and have been on edge ever since this mortgage finance mess began to give off its distinctive odor. Clearly, the Treasury Department could not afford to play a losing game of "Whack-A-Mole" with either Freddie Mac's or Fannie Mae's accounting surprises.

The second factor was not raucous Wall Street, but the quiet, paneled rooms of central banks in Europe and Asia, which together hold nearly $1 trillion in mortgage-backed debt guaranteed by Fannie Mae and Freddie Mac. China alone holds an estimated $300 billion of this debt and has reportedly made it very clear that it has no taste for either accounting surprises or the legal subtleties of government-sponsored-entities. As far as China was concerned, it held the U.S. government's IOUs and expected to be paid in full. Europe has been quieter but, we would guess, no less insistent.

The net effect was that the Treasury Department had no choice. In order to take responsibility it had to take over.

The takeover means that stockholders in Fannie Mae and Freddie Mac are moved to last place in terms of their claims on the companies' assets—effectively rendering the stock worthless. There will be few tears shed for those who hold common stock. After all, the bad news and the precipitous decline in the mortgage companies' share prices over the past few months, it would be a singularly uninformed investor who did not consider the stock to be speculative.

The preferred stock, however, is another matter, and some steps may need to be taken to deal with the takeover's collateral damage. Preferred stocks do not carry voting privileges, so the owners bear no direct responsibility for Freddie and Fannie's bone-headed management.

Many banks that hold that preferred stock will be looking at big holes in their balance sheets. The losses are so significant that analysts estimate as many as 40 smaller banks around the country will be forced to find replacement capital to stay afloat.

Even banking giant Wells Fargo, widely praised for its skillful avoidance of the sub-prime credit mess, finds itself staring at a $480 million loss from its Fannie and Freddie preferred stock holdings. It is not a big enough loss to impair its capital position, but it's no fun, either.

Treasury's takeover of Fannie Mae and Freddy Mac was organized as a conservatorship, a flexible structure which allows for a considerable exercise of judgment. Perhaps the government will review the unintended consequences of its takeover and make some adjustments to accommodate the holders of preferred shares. Certainly, the Treasury Department does not wish its takeover action to bring further woe to the banking system.


The final cost to the taxpayers of this takeover may not be as much as now projected. If the takeover calms the financial market waters and gives hope to the housing market, the write-downs may not be as severe as predicted. And as the critics of the takeover come out of Wall Street's woodwork, we need to keep our perspective: Treasury, in fact, had no choice.