I will manfully resist saying "I told you s…", er, in response to this Friday news dump:
The government has formulated a plan to put troubled mortgage giants Fannie Mae and Freddie Mac under federal control, dismiss their top executives, and use government funds to prop them up…
Under the plan, the federal government would place the firms in a legal state known as conservatorship, the sources said. The value of the company’s common stock would be diluted but not wiped out while the holdings of other securities, including company debt and preferred shares, would be protected by the government.
Details are scarce, my best guess based on past musing is that they will issue preferred stock that the government will buy as their means of putting money into the two companies. Because that stock will have preference over common shares, the value of common shares will plummet, but not be wiped out. Debtors won’t lose a cent, probably intended to avoid a cascade of credit swaps, as Morgenson pointed out. The original plan was to also wipe out preferred shares by making the new shares senior even to them, it looks like Paulson blinked on that.
This was probably necessary, and all the happy talk about how the cost of the bailout would only be 5 to 25 billion should now be seen as being as empty as it always was. If the bailout was only going to be 25 billion, this wouldn’t be happening.
From a public policy point of view this is a bad way of doing something that’s necessary. There’s no particular reason why preferred shareholders shouldn’t be wiped out along with common shareholders – owners of companies that go belly up should lose everything. Likewise, men like Pimco’s Bill Gross made big bets by piling into Freddie and Fannie’s debt in the expectation of a government bailout, when they knew that the debt was bad if the government didn’t bail Freddie and Fannie out, and they are going to win those bets. Again, when normal companies go belly up, debtors don’t get all their money up and one shouldn’t be rewarding men who deliberately bought debt they knew was bad. Going into conservatorship is the equivalent of going belly up. Bondholders should take a haircut—they shouldn’t lose everything, but they should certainly lose whatever they would have lost if Freddie and Fannie had been allowed to go bankrupt like normal companies. To not do so is a clear case of moral risk; a clear case of bailing investors out of their own bad decisions; and a clear case of shifting money from taxpayers to private interests.
Or, in other words, privatize the profits, socialize the risk.
Obviously, as Ishmael pointed out, bondholders (many of whom are foreign governments who are very unhappy about what is happening to their US holdings) put the pressure on, hard, and Treasury has folded.
Freddie and Fannie had to be bailed out, don’t get me wrong, but this is about the worst way of doing it if your idea was to avoid moral risk and to protect the taxpayer’s pocketbook, rather than those of investors.
I am also amused by two other items—first that they are going to dribble the money in in bits, rather than ponying up soon: Paulson "I won’t be around when the real bill hits. Phew!"
And second, this:
Executives of the two companies were told to show up without being told of an agenda. Daniel Mudd, chief executive of Fannie Mae, was accompanied by outside lawyers.
Yeah… these guys know they were negligent at best. If I were Mudd, I’d keep lawyering up.
I will maintain my prediction that when all the costs are added up, years from now, the total bill will come to close to half a trillion.
Related posts:
Spotlight
Support this site!
Subscribe to the newsletter
Advertise on Firedoglake
Send
us your tips
Make us your homepage
About Firedoglake
Advanced search
I am picturing George W. Bush scanning the paragraph into which some hapless staffer had to condense this latest development, and then yawwwwwwning. Past his bedtime, after all…
Hi, Ian. I think we all had a feeling this was coming. Interesting that the news dump, such as it is, comes immediately after the Olympics and 2 political conventions when everyone, as you can see, is asleep.
I think I owe you the beverage of your choice…! What’s your preference?
I think the fear of giving the bondholders a haircut was that they would refuse to buy future issues, effectively cutting off one of the few, if not only, current sources of mortgage funding.
Well, he’s pretty good at seeing businesses fail… it’s his forte after all, Harken Energy/Arbusto are his trademark “successes” in the world of high-finance MBA adventures with Daddy and Saudi/bin Laden money.
Those a**holes mortgaged our future and they’re going to walk away with minor slaps on the wrist….
Eh, there’s not a surplus of bond opportunities. Do it in one fell swoop and no worries. Except perhaps for the foreing countries. That could be a problem, but only in the sense they might decide to start dumping. A real possibility and threats along those lines might get my attention.
But one problem in the world today is that there’s too much investment demand chasing too little investment supply.
Speaking of businesses failing, John McCain might want to have a word with his son . . .
Or maybe Cindy should have a word with him. She’s the one with the $$, after all.
Which should drive interest rates up, but we can’t have that in an election year, right?
How long ago did you predict it, Ian…?
I was under the impression that much of the funding was foreign and that dumping was at least perceived to be the likely result.
I agree with your last line, way too much capital chasing too few investment opportunities.
Should be $25 billion.
Is there something about republicans and failing banks? Or am I just a clueless whiner?
Woops. Thanks Dave.
Sarah Palin has a lot to learn! Back home, she taxes Big Oil (bad governor, no mooseburger tonight) and gives the money to all the citizens of the state. In Washington, she’s got to learn the proper use of Shock Doctrine to transfer wealth vertically upwards.
[Typo alert, “million” at the end of paragraph 5 meant to be “billion”?]
Digg it here!
The apple falleth not far from the tree… Keating, anyone? S&L bail-out, anyone?
Oh, sorry… Forgot to answer your question. Yes. You are a clueless whiner. I’m sure Phil Gramm will take time out from his busy schedule to explain it all to you.
i wonder if this wasn’t a done deal a long time ago – maybe promises were made in order to get sovereign wealth funds to buy in?
I’ll have to search my archives, not sure. But, I think a search of bopnews archives would probably show something from 3 years ago or so.
707!!!!
like I need a verbal spanking from the Mock-Turtle and his wifey, Ms. Wendy Enron.
men like Pimco’s Bill Gross made big bets by piling into Freddie and Fannie’s debt in the expectation of a government bailout, when they knew that the debt was bad if the government didn’t bail Freddie and Fannie out, and they are going to win those bets.
shit. Why wasn’t I born with just a *little* instinct for Republican corrupt capitalism?
Being a Republican means never having to say you’re sorry.
Could be. The whole foreign reserve thing is such a mess. All these countries have a gun aimed at America’s head, and the only thing stopping them from pulling the trigger is that they’ll get some blowback as well. I’m honestly not sure how to handle it in the short run. In the medium run, the job is to get the balance of payments under control and increase the US savings rate and that’s going to be painful. The simplest way to do both might be to tell China and co. to bugger off “pull the trigger if you want”. I think that’s what I would have said “sure, go ahead and start a worldwide depression. Up to you.”
So, speaking of Phil Gramm, they wouldn’t be stupid enough to put him in charge, would they?
Yes.
This has been another chapter of…
No, first he asked hard questions about how it would affect his portfolio.
This phrase is pitch perfect:
“Or, in other words, privatize the profits, socialize the risk.”
THEN he yawned and looked at his watch.
Bob in HI
I’ll just bet that Andy has no financial exposure here whatsoever; that’s the whole point of hanging out with banks like this. Anyway, since he was on the audit committee until he resigned in July it’s likely he had plenty of take-cover lead time.
Btw, you might want to leave a little spot in your Friday webbing for bank failures; the FDIC tends to act then in order to reduce the chances of a run before they can take over.
We wouldn’t be in this mess if Bill Clinton hadn’t deregulated Fannie Mae. Thanks Bill.
Wow, he was on the board from February until July 29 and managed to drive them to ruin. Oh well, maybe now he will team up with Neil Bush to create a new software package George Sr. and Babs can contribute to future hurricane relief.
I have two questios totally unrelated.
1. Are the decisions which will need to be made something which must go through congress, have the authorities to do whatever been passed to treasury.
2.It is my impression that as the mortgage crisis began to emerge a great deal of money took flight and wound up in such things as energy futures is there any danger of this kind of thing reoccurring?
To #2
Actually, with the fed backing Fannie and Freddie investors will be moving back into financial stocks (because of the lowered risk on mortgage defaults, no being backed by the govt) and move away from oil, gold, and other bear market investments.
Privatize profits, socialize losses.
Capitalism: the Unknown Ideal!
I blame the Liberal Media and absence of School Prayer.
In 1994 Bill Clinton deregulated Fannie Mae to open lending to lower income families.
Socialize mortgage insurance, socialize the losses.
Shock Doctrine
Ti exactly what it is! This has all the earmarks sadly.
1. Congress essentially gave Treasury a blank check (well, up to the debt ceiling) so no, they don’t need to go back unless it blows past about 100 billion. Which it may, but not in the next few months, I don’t think. (If it does either they’re really cleaning house or hell is breaking lose.)
2. This is a part of the “shortage of investment options” thing, there just aren’t a lot of good places to put money right now where you get a return and don’t have much risk of loss. I don’t think Freddie/Fannie will cause this, because I just don’t know where they can find to create a bubble any more. There will probably be a pile back into energy/commodities/food at some point, but not this year, I think.
The problem is that risk is so high in so many places that the rational thing to do with money, in many cases, is pretty much to stick it under a mattress.
iirc, john q treasury was worried about what would happen to fannie and freddie about 4 years ago?
Good point. Although at the height of the housing market, their share was only (iirc) about 30%, so there’s still a ton of trash out there. But it is some relief to a lot firms that hold their crap.
Yup. I really should start writing those again. Not sure they’d fit well at FDL though.
Alongside the repeal of the Glass-Steagall Act…
i’d want to know what their plans B through Z were first – they might have other ways, with less blowback to them, of punishing us.
It’s not about the $$$ anymore, it’s about the perception that the solution has been enacted. From an investors point of view at least.
ya mean no mo cheap stuff??
Oh yes, this was a bipartisan screwup. That said, while Clinton made it possible, Greenspan and Bush made it happen.
bill removed the locks from the doors, and his good buddies at bushco said “thank you” as they looted the house.
i really despise clinton – not just because of what he did, but because he’s gotten away with it. we really need to hold him accountable for his polices of deregulation and privatization if we don’t want the next D president to have license to give us another round of “let’s unlock the doors so the crooks will have easy access.”
I blame Michael Douglas
For a while. The $$$$$ will come back to be an issue. For many years psychology trumped accounting and gravity, but gravity has hold. I don’t think housing prices are going to stop their decline for another 3 years, minimum, and due to the miracle of leverage in reverse, that’s going to be extremely painful — and while this covers a lot of that, in terms of defaults, a lot of it still isn’t covered.
But it is a huge bailout, that’s why I keep saying I don’t believe the 25 billion or even 100 billion number.
OTOH, there should be an Obama economic bounce when money gets redeployed properly into real stimulus rather than very inefficient stimulus like the Iraq war. That may help.
You think that possibly that’s why this is being done through Treasury and not the Fed?
I haven’t really thought much about this whole mess from the perspective of handling the foreign creditors, not that that wasn’t an obvious problem, but it was always clear to me that the behavior of the mortgage lenders and the securitizers who played off them was conditioned partly by an assumed, or rather presumed, backstop from the federal government.
There’s the Fed, Treasury, FHLBs (Fed Home Loan Banks), and Freddie/Fannie. The FHLBs are too small, getting their operating money from member dues, with only a small part of the overall problem being eligible members, and they can only do business with the members. (Ditto FDIC, which also has to wait for its member actually to fail before it can help it.)
I think the Fed was able to say no to taking over the lead, and made it stick somehow; the word “hyperinflation” might have figured into the conversation, or maybe they actually showed a greater willingness to play the chicken game Ian suggested than other parts of the government. So with Fannie/Freddie —the immediate black hole for a lot of bad paper— and the Treasury left looking at each other, I guess F/F said, “Well, but only if you use that new bill Congress gave you.”
Couldn’t agree more, but it started with Clinton.
I think Bernanke is damaged and Paulson isn’t, is mostly the reason. Bernanke’s solution was to pour gas (liquidity) on the problem and the end result was massive commodity inflation. So he’s backed off and Paulson is now the lead horse on this.
The only true “stimulus” for the market is to lower corporate tax rates and bring business back to the US.
I have a better idea. How about we privatize the losses and socialize the profits? Of course either way the Busheviks will just screw it up royally. These fuckwads couldn’t change a light bulb with a manual and a coach.
The demise of Glass-Steagall is proof that those who do not remember the past are condemned to repeat it.
Great Depression, The Sequel anyone?
yes! yes! yes!
duh. the blog with “pull up a chair” and “late late nite” parties can’t have a little fun with some fiction that teaches and entertains? there is only one good reason i can think of for you not bringing back john q – and that is if you don’t enjoy writing about him. i don’t think i’d be the only one here who would enjoy reading about his latest adventures. *g*
That’s certainly the McCain line. It wouldn’t be my solution.
jane upstairs
Yep…and that movie was a pale imitation of what the actual greed in the financial markets has been in recent years.
We’ve all been played. Wall Street started bringing in quant jocks in the early 80s to sex up increasingly sophisticated financial instruments…especially mortgage backed securities. No “normal” people (much less legislators, regulators, attorneys) could understand this stuff. And worse, the oversight mechanisms were antiquated and underfunded.
Ever since the repeal of Glass-Steagall, have been waiting to watch the tsunami. These machinations are like Ponzi schemes on steroids. Makes the Enron crowd look like amateurs.
Strongly recommended reading on the origin of the banking crisis: Chain of Blame by Paul Muolo and Mathew Padilla. They trace the changes in the mortgage lending industry to very specific actions, which makes their account a little weedy maybe, but details is where the devil definitely is in this tale. I’ll be reading it through for the second time soon.
I don’t often disagree with Ian, but except for the preferred stock, this seems like the right way to go. The speculators in bonds guessed that the government would meet its “moral obligation” to Fannie and Freddie, and make good on the bonds. In the process, they put a floor under the price of the bonds, preventing a deeper drop, and stopping a run on the debt instruments that could have been catastrophic. It would have undermined the confidence of foreign investors who hold huge amounts of debt. It could have damaged banks, which hold Freddie and Fannie debt as part of their capital structures. It might even have hurt me, because I have money in mutual funds which hold this debt along with treasuries. I don’t have a problem with them winning their bets.
Look at the correlation between the countries that attract US jobs, and their corresponding corporate tax rates. You’ll see the issue. You bring business to the US by making it attractive for them to be here.
who’s going to pay for it?
The issue isn’t quite that simple. To put it mildly. What matters is the cost of doing business + shipping costs. Corporate taxes are not the most important part of that. Single payor universal would do more for major companies than anything but a major tax cut.
If the US wants to compete on cost, it will lose. Period. You cannot compete with labor costs in the China, India and the third world. Corporate taxes are not the main issue, they are only part of the chain.
While there has been a great deal of attention paid to the residential problems, hasn’t commercial RE held up and isn’t it showing increasing signs of duress
with things like single payer health care for employees. not with low corporate taxes – that’s just a race to the bottom.
The government, over the past few years, explicitly said there was no implicit guarantee. But the larger point is simpler: its not a free market if you keep bailing everyone out and if you keep bailing people out they’ll never learn, so we’ll have to go through this again in 10 years if they manage to pull it out again. And next time will be worse, guaranteed.
Then what is the solution?
You’re right, you can’t compete on labor, but R&D and higher end positions are much more costly in the us due to the corporate tax.
There IS another way make every foreign company/corporation pay a premium for access to OUR markets. I mean if we the tax payer is on the hook why should corporations get lower taxes?? We the little people are being screwed again by big money… I say make them pay for access sounds protectionist I know but it may be the only way to reign in the constant BS of putting us in the business of bailing out the big guys… Where is OUR payback??? Poor schools, no health care etc etc… Come on kiddies this is just more of the big money trying to make more money!!
Taxpayers are going to pay. That was the underlying premise of the “moral obligation”. The benefit to the public was the increase in availability of mortgage money, at lower prices than would have been available otherwise.
Commercial is down just as much due to the lack of credit available to borrowers. Stemming from the residential losses.
Okay, I’m going to bed. It has been a pleasure discussing with you all. Good night and have a great weekend.
And the operative principle here is that the greedy will reap rapacious profits in the runups of markets. They have usually escaped any punishment relative to their “crimes” because of the scale of their looting. The government has acted as if they are more invested in maintaining the appearance of fair markets.
Maybe a few more perp walks and “hanging judges” would help?
Nobody really believed the government wouldn’t bail out the debt, especially this crowd of crony capitalists. Even after the problems appeared, very recently, both completed the sales of refinancing debt at favorable prices.
But there does not appear near the ampunt of default problems.
A little too much to go into here, but I would try and get comparative advantage working again by getting currency markets back under control so that currency movements are mainly determined by trade flows.
http://firedoglake.com/2007/09/29/ricardos-caveat/
Also remember that many companies pay no tax, because they have no income under tax accounting.
America’s cost structure is just uncompetitively high – we’re talking about housing for example, and frankly, while it’ll cause a lot of pain and risks deflation, still, there’s a huge upside to housing costs crashing because that’s a big part of why the US costs so much to do business in.
Many economists think that there’s nothing that can be done to stop America’s standard of living from declining, meeting China/India’s somewhere in the middle on the way up. But no one wants to go out and tell that straight to Americans.
Apparently they were right. But they shouldn’t have been. And taxpayer’s got squat, the .5% off house financing (which is the estimate of the effect, iirc) was used for far too many loans which should never, ever, have been made so that Fannie and Freddie’s executives could book fake profits so they could pay themselves massive bonusses. Now a lot of Americans are going to lose their houses, because Freddie, Fannie and many others made loans they should never, ever, have made.
Again, Freddie and Fannie needed to be bailed out. But I see no reason why bondholders shouldn’t take a haircut too. And if they then want to dump, let them, they’ll lose even more money than if they hold still and take their haircut.
Another major cost is medical. The absurdities of the medical system costs are a mjor factor. Looking at why those costs are so high 1. Insurance costs $1 out of every $3. labor and equip as well as high real estate costs
that wasn’t much of a benefit if it was most ARMs.
i think the tax payer is getting ripped off. but i don’t understand the economics, only the incentives (a very little bit).
Ian, I see people complaining about corporate taxes in this country. I recently read a transcript from an early 1930’s congressional hearing of the head of the NYSE. The Senator threatened to put a sales tax on equity transactions. The head of the NYSE replied that the exchange would be moved out of the country if that happened.
My question is, what is the downside of taxing equity and bond trades and futures markets. Like a sales tax. Keep it low, not crippling. And tax the corporations that way rather than directly. It also seems it would take a little of the heat out of the markets.
What is wrong with this as a revenue source for government?
Everybody in America pays sales tax on most stuff we buy and sell.
i’ll buy it when the top 1% and especially the top 0.1% take the hit in standard of living too. that’s what is required to have a chance to get the public to buy in. and that is not what is going to happen if our political class has anything to say about it.
CRE defaults are coming. It’s a slow-motion collapse of financials. Calculated Risk:
CRE Loan Concerns Grow
Thank you for the link – that was the point I was trying to make
(((IAN))))
Lead a horse to water..can’t make em drink. Post more often and frequently.
Solid food is good with all the fluff.
I think we are a long way from the bottom. we are going to see an increasing number of sectors falling into crisis. Prediction: next sector to see problems will be hospitality.
I’m not sure “go ahead, make my day!” was a realistic option for the US Treasury – the potential repercussions for the world economy were too great, which is why Bernanke blinked on Bear Stearns in a different context. The US is not Argentina.
Sorry I’m late Ian but just how bad are things at Fannie and Freddie if Bush couldn’t wait until after the election to spring the news?
There is no doubt that this will hurt McCain especially with the McCain son’s bank going belly up.
If the problem is good places for investors to put money with low risk, then what difference would lower corp. tax rates make?
What you need is the Green Revolution or somesuch to actually create REAL stuff and then the financials can track that.
What Bush & Co tried to do before to F&F was to scare people into thinking it was crashing so they’d sell out and then they could walk away with a lot of wealth for pennies.
Is that what’s happening now or is there a real plan to simply steal it?
Bush & Co. — America’s biggest mafia!
Bernanke should spank ‘em all hard!
If capital gains are higher, then certain investments become less profitable. Secondary securities markets are necessary to ensure that people have liquidity for primary investments – that’s the argument and it’s true. There are things you can do, however, the primary of which is to tax short term capital gains very highly and long terms gains fairly low. I don’t think there’s much in the way of good arguments against that, frankly, as I don’t think most debt should be short term (actually debt should match duration to whatever the term of what you’re using it for, but that’s a whole can of worms.)
Anyway, short answer – unearned income should be taxed the same as earned income, and I would make an exception for primary investments held at least 3 years and secondary investments held at least five. Exact numbers can be quibbled.
To deal with the “go elsewhere” issue you simply put currency controls back in place, which they should be anyway. If you want to live somewhere else, great, but if you don’t, then you’re screwed. And if you want to invest in the US, your money more or less stays in the US. Yes, this would mean a decline in foreign investment that’s largely a good thing. It would be possible to get money out, but it would take time.
It’s a game of chicken. The same considerations are at play with other central banks. There has been no decoupling. If China pulls the trigger they blow the bottom out of the boat they’re in too.
If you wait that long, you might not get the bailout on such good terms, since there’d be a new Secretary of the Treasury. It’s not just me calling for bondholders to take a haircut, this ain’t a hippy position, lots of perfectly mainstream economists, hedge fund managers and so on are calling for the same thing (if, unlike Gross, they don’t own that stuff.)
EPU territory, oh well.
Some time back, Nouriel Roubini predicted F/F woes — and reckoned the total bill would be over one *trillion* … more lately, he’s revised upward: to TWO trillion.
An analysis by one Don Rich a couple of days ago crunched the numbers to a worst-case outcome of 2.5 trillion. Yikes!
haha. I’m behind the curve. Nouriel used to be predicting 2 trillion for the entire credit crisis, not just for f/f. Are you sure it was just f/f?
I don’t agree with the assessment of Paulson, but it’s unusual here at FDL to see someone admitting that the commodity inflation was due to Fed policy and the speculation it induced in those markets.
The post is full of good information, but the suggestion that anything like policy failure or wrong choices misunderestimates the motivations for them. The intent right from the start was to socialize the bad private debt generated by Greenspan’s financial bubble policy run amok. To arrange for only selected stockholders to recover (or cover) their losses is pure gravy, in my estimation. There are no errors or miscalculations going on here. It is quite systematic and deliberate, what they’re doing.
Paulson takes over as he is capable of acting completely without compunction. Bernanke is more the academic who’s vain about his own theories of monetary policy, enough so, to risk extreme havoc for the general run of people in order to test them.
I’m not sure if you’re blaming China. If you are I think it unfair unless you blame them for being an enabler which may have some validity. The thing I like about our government is that it seems ready to bail out everyone in sight, a neat trick for an outfit that runs serious deficits.
Fannie and Fredie present a great opportunity for a pool. We should each put in a buck and pick the final cost. My bet is an even trillion. Don’t know how long the world will keep running our tab.
Abolutely right, Clinton is also culpable in my view.