Decision ‘08

No Rescue Of Fannie and Freddie? There Almost Was…

…and who knows, maybe there will be yet. The Washington Post reports, however, that it almost happened Friday:

Senior government officials prepared emergency steps yesterday to rescue troubled mortgage giants Fannie Mae and Freddie Mac but stopped short after a campaign of public statements eased immediate concerns about the stability of the institutions.

But federal regulators were forced yesterday to seize California-based IndyMac Bancorp after a run by depositors led to the second-largest failure ever of a U.S. financial institution. The bank, which was taken over by the Federal Deposit Insurance Corp., became the first major bank to shutter its doors since the savings and loan crisis of the early 1990s. One of the country’s largest home lenders, IndyMac saw its holdings battered by the downturn in the housing market.

Similar troubles have buffeted Fannie Mae and Freddie Mac as anxiety has risen about whether the companies have enough capital to cover their mounting obligations because of troubled mortgages. With the companies’ stock value draining away in recent days, Treasury Department and Federal Reserve officials have been discussing several dramatic options, including allowing the companies to swap some of their holdings in troubled securities for public money as well as accessing government loans, according to government officials and others informed about the measures. Fannie Mae and Freddie Mac might also be allowed to tap an expanded line of credit from the Treasury.

Such actions would be the first explicit statement by the government that it stands behind the two companies, though investors have long considered a federal guarantee to be implicit. That recognition alone could prove more valuable than the cash.

…These steps are an effort to prevent a full federal government takeover of the companies, which could occur if they are deemed insolvent. Such an arrangement, called conservatorship, would mean that taxpayers would have to cover the potentially tremendous losses on any mortgages the companies own or guarantee.

In recent months, Fannie Mae and Freddie Mac’s role in underpinning the housing market has grown as other financial institutions have fled the credit markets. The companies, chartered by the federal government to keep funds flowing to mortgage lenders, pool mortgages into securities for sale to investors. Fannie Mae and Freddie Mac pledge they will cover the payments if borrowers default, and they also buy and hold their own mortgage investments.

Together, they bought about two-thirds of the single-family-home mortgages that originated from January to March of this year, according to their regulator, the Office Federal Housing Enterprise Oversight.

I held off on commenting on this for a couple of days while I pondered what I thought the right government response is. Clearly, Fannie and Freddie are too integrated into our housing situation nationwide to fail. That, in itself, is a problem. We have to foster a system that doesn’t put so many of our eggs into two baskets. To say that is one thing; to do it quite another. I’m not sure how we do that, but I do know that when you have companies ‘too big to fail’ in what is essentially a mostly capitalist economy, your policies are wrong (or your loyalty to capitalism stops short of actual widespread pain, more likely, and you discover your inner socialist).

More immediately, however, I oppose putting high-risk mortages onto the taxpayer tab, as a government takeover would entail (funny, to call mortgages high-risk, when a few years ago, they were considered golden safe harbors - but given the current conditions, they are very high-risk). For the same reason, I oppose a swap for public money as detailed above.

I do applaud the government for not rushing into the panic as last week closed, and I think greater access to loans and lines of credit is the best way forward, as (at least ostensibly) the shareholders would still be on the line to pay the taxpayers back. Our elected officals, however, did not show the same caution, as some are blaming the takeover of IndyMac at least partly on a very public attack by NY Senator Charles Schumer:

IndyMac came under fire last month from U.S. Senator Charles Schumer, who said lax lending standards and deposits purchased from third parties left it on the brink of failure. In the 11 business days after Schumer explained his concerns in a June 26 letter, depositors withdrew more than $1.3 billion, the OTS said.

“This institution failed due to a liquidity crisis,” OTS Director John Reich said in the statement. “Although this institution was already in distress, I am troubled by any interference in the regulatory process.”

Schumer blamed IndyMac’s own actions and regulatory failures for the seizure.

“If OTS had done its job as regulator and not let IndyMac’s poor and loose lending practices continue, we wouldn’t be where we are today,” Schumer, a New York Democrat, said in an e-mail today. “Instead of pointing false fingers of blame, OTS should start doing its job to prevent future IndyMacs.”

(The OTS is the Office of Thrift Supervision, by the way). While I don’t doubt that the OTS and IndyMac itself should take plenty of the blame, even the lion’s share, it is troubling that the mouthing off a U.S. Senator essentially caused a run on the bank and put the risky obligations he was railing against onto the taxpayer’s shoulders. If nothing else, it shows that in a shaky economy like this, government and elected officials need to choose their public words with extreme caution…

UPDATE 2:39 p.m.: Tomorrow, Freddie tries to sell $3 billion in securities, and the federal government is lobbying on its behalf:

Though officials said they were optimistic the sale would be a success, anything less would pose new questions about how far the federal government is willing to go to prop up Freddie Mac, its sister Fannie Mae and other faltering financial enterprises.

Officials spoke yesterday with major banks that normally purchase securities, like the short-term debt offered by Freddie, to ensure these firms still plan to place bids tomorrow. This was part of an effort by officials at Treasury, the Federal Reserve and other agencies this weekend to gauge market sentiment and check that investors still have faith in Freddie Mac and Fannie Mae after the steep decline in their stock prices last week.

At the same time, Treasury officials were considering several options to backstop the sale in case they discover that interest in the securities is flagging, according to sources familiar with the discussions. Under one alternative, the Treasury or Fed would purchase the securities directly.

Well, the lobbying is unseemly enough, though perhaps necessary, but the idea that the Fed or the Treasury would purchase the securities directly is troubling. It puts the taxpayers in the position of purchasing securities that the markets deemed an unsafe bet. That can’t possibly be a wise policy. I’m becoming increasingly uncomfortable with this situation, not least with the increasingly activist stance of the government…

UPDATE 9:44 p.m.: Underscoring the seriousness of the situation, events continue to move even on the weekend. Treasury Secretary Paulson issued the following statement today:

Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.

GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure.

In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately.

First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.

Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.

Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer.

Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator’s process for setting capital requirements and other prudential standards.

I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.

Notice I highlighted the line about protection for the taxpayer. It would be nice to know a little more than just a single line about that aspect, no?…

UPDATE 9:48 p.m.: More from the NY Times:

Alarmed by the sharply eroding confidence in the nation’s two largest mortgage finance companies, the Bush administration on Sunday asked Congress to approve a sweeping rescue package that would give officials the power to inject billions of federal dollars into the beleaguered companies through investments and loans.

In a separate announcement, the Federal Reserve said that it would make one of its short-term lending programs available to the two companies, Fannie Mae and Freddie Mac. The Fed said that it had made its decision “to promote the availability of home mortgage credit during a period of stress in financial markets.”

An official said the Fed’s lending program was approved at the request of the Treasury, but that it was temporary and would probably end once Congress approved Treasury’s plan. Some officials briefed on the plan said Congress could be asked to extend the total line of credit to the institutions to $300 billion.

The actions, which taken together could provide an overwhelming surge of capital to the companies, were the second time in four months that the housing crisis had prompted the government to scramble over a weekend to rescue a major financial institution. Last March, the Treasury Department engineered the sale of Bear Stearns to prevent it from going into bankruptcy and cause a shock to the financial system.

The plan was disclosed on Sunday evening to calm jittery markets overseas and on Wall Street in advance of a debt sale by Freddie Mac on Monday morning. Officials said that after talking to senior lawmakers through the weekend, they expected that Congress would attach the proposals to a housing bill that could be completed and sent to the White House for approval as early as this week.

“The president has asked me to work with Congress to act on this plan immediately,” the Treasury secretary, Henry M. Paulson Jr., said Sunday on the steps of the Treasury building. “Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.”

While senior Democratic and Republican officials in successive administrations have for many years repeatedly denied that the trillions of dollars of debt the companies issued is guaranteed, the package, if adopted, would bring the Treasury closer than ever to exposing taxpayers to potentially huge new liabilities. The two companies could face significant new losses this year as the wave of housing foreclosures continues.

Officials seemed to suggest, however, that they had little choice. Over the weekend, Treasury officials sought assurances from Wall Street firms that a $3 billion auction by Freddie Mac of short-term debt would go off without a hitch. While $3 billion is a relatively small sum for an institution of Freddie’s size officials said they did not want to risk that even a small misstep that could set off a new round of problems.

The government officials said that the more drastic alternative that has been considered — placing one or both companies under the control of a government-appointed conservator — would be done only as a last-ditch measure if the intermediate steps failed to restore confidence.

They said they were prompted to act because, despite repeated assurances by top officials that the companies had adequate cash to weather the current financial storm, Fannie and Freddie suffered a withering blow of confidence last week when their stocks plummeted on the New York Stock Exchange. As a result, Freddie Mac faced an uncertain debt offering on Monday.

The failure of just one of the companies could be catastrophic for economies around the world. The companies, known as government-sponsored enterprises, or G.S.E.’s, touch nearly half of the nation’s mortgages by either owning or guaranteeing them, and the debt securities they issue to finance their operations are widely owned by foreign governments, pension funds, mutual funds, big companies and other large institutional investors.

People are referring to this as a rescue package, so I guess my headline is already obsolete…

One Response to “No Rescue Of Fannie and Freddie? There Almost Was…”

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July 16th, 2008 at 11:20 pm
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