/ 31 August 2008

US government ‘bazooka’ may save Fannie, Freddie

Can Treasury Secretary Henry Paulson's "bazooka" save mortgage finance titans Fannie Mae and Freddie Mac from a calamitous meltdown?

Can Treasury Secretary Henry Paulson’s “bazooka” save mortgage finance titans Fannie Mae and Freddie Mac from a calamitous meltdown?

The two groups that underpin trillions of dollars in mortgages are facing a crisis that could force the United States government to step in and possibly nationalise them, but some say the mere promise of massive aid may be enough to restore confidence.

Fannie and Freddie, government-chartered, shareholder-owned firms that provide liquidity to the housing market, have been whipsawed by the financial meltdown in the past year, losing about 90% of their value on fears of losses from mortgage defaults.

Fred Dickson at DA Davidson & Company said investors are increasingly worried about the outlook.

“To put the problem in perspective, Fannie and Freddie have a collective market value of $8,1-billion in insurance protection exposure for more than $5,5-trillion in insured mortgage instruments,” he said.

A law enacted in July gives the US government the authority to buy shares or offer liquidity to the companies to keep them afloat, averting what some fear could be a major shock to an already fragile global financial system.

Paulson, speaking to Congress last month, said this is a powerful tool that may restore confidence even if it is not used.

“If you’ve got a squirt gun in your pocket you may have to take it out,” Paulson explained. “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”

Yet the roller-coaster ride for the two government-sponsored enterprises (GSEs) has continued.

“We do not believe the GSEs will be successful in raising capital in the public markets on economically feasible terms,” said Tim Anderson, analyst at Riverfront Investment Group.

“This will likely mark the end of the GSEs in their current format as an awkward public/private hybrid. We believe the GSEs will be nationalised in some form.”

Joel Naroff at Naroff Economic Advisors said the prospect of nationalisation may be scaring off investors.

“It almost creates a self-fulfilling prophecy,” Naroff said, noting that any government bail-out might leave shareholders with little or nothing.

“After what happened with Bear Stearns, the government can’t come in and save the equity holders,” Naroff said. “I don’t think that’s politically viable.”

‘What a mess’
Ed Yardeni at Yardeni Research said the shareholders “will be wiped out” by a government takeover, but small banks that hold the shares could also be hurt.

“The Treasury may have to bail out holders of their preferred shares as well as their debt. Otherwise, small banks may suffer another round of large losses,” he said. “What a mess.”

Mark Zandi, chief economist at Economy.com, said other options exist aside from a government takeover of the two GSEs.

“Breaking them up would be messier than some critics think, and nationalisation isn’t the best way to bring mortgage rates back down,” Zandi said.

“Better would be an unequivocal statement from the Treasury Department saying that the GSEs’ debt holders will not lose money. Whatever policymakers decide to do, they should do it quickly, as the uncertainty threatens to upend the fragile financial system and housing market.”

Analyst Alec Phillips at Goldman Sachs said the prospect of a bailout is daunting since the GSEs own or guarantee about $5,3-trillion in mortgage debt — roughly the same amount as the entire government debt.

But he said Fannie and Freddie debt is “backed by high-quality assets … which generate income,” and that an intervention would be “small in the federal context.”

Fannie and Freddie got some relief from the market swoon after Citigroup analyst Bradley Ball suggested they could muddle through without government help.

Ball argued in a research report that the GSEs have “adequate” capital and can continue to absorb losses through the second half of 2008.

Others were sceptical.

Dan Denning, analyst at the financial website The Daily Reckoning, argued that a takeover may be forced on the Treasury if the housing market continues to sink.

“It looks obvious now that Henry Paulson is outgunned,” he said.

“Never bring a squirt gun to a gunfight, Mr Paulson. What the market really wants to know is what the Treasury is prepared to do. And so the market has called Paulson’s bluff.” – AFP