Fannie & Freddie Plan Released: Treasury Follows PrefBlog's Plan!

A WSJ article states:

The Treasury said its senior preferred stock purchase agreement includes and upfront $1 billion issuance of senior preferred stock with a 10% coupon from each GSE, quarterly dividend payments, warrants representing an ownership stake of 79.9% in each firm going forward, and a quarterly fee starting in 2010.

A press conference was held by Treasurey Secretary Paulson and FHFA Director Lockhart, with a press release issued by Treasury:

[Paulson said] Their statutory capital requirements are thin and poorly defined as compared to other institutions.

… but did not report his resignation.

[Lockhart said] To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size.

Treasury has taken three additional steps to complement FHFA’s decision to place both enterprises in conservatorship. First, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations. It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares.

Lockhart also disclosed some startling news:

While conservatorship does not eliminate the common stock, it does place common shareholders last in terms of claims on the assets of the enterprise.

Similarly, conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses.

Amazing! Common shareholders take first loss, preferred shareholders take second loss. Who would have thunk it?

Preferred stock investors should recognize that the GSEs are unlike any other financial institutions and consequently GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly. By stabilizing the GSEs so they can better perform their mission, today’s action should accelerate stabilization in the housing market, ultimately benefiting financial institutions. The broader market for preferred stock issuance should continue to remain available for well-capitalized institutions.

This is interesting. Is Treasury preparing for a pre-packaged Chapter 11 at some time in the future?

Lockhart concluded:

Because the GSEs are Congressionally-chartered, only Congress can address the inherent conflict of attempting to serve both shareholders and a public mission. The new Congress and the next Administration must decide what role government in general, and these entities in particular, should play in the housing market. There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes. And policymakers must address the issue of systemic risk.

In the weeks to come, I will describe my views on long term reform. I look forward to engaging in that timely and necessary debate.

Several reports are attached:

REPORTS

From the Preferred Stock Purchase Agreement:

In exchange for entering into these agreements with the GSEs, Treasury will immediately receive the following compensation:
  • $1 billion of senior preferred stock in each GSE
  • Warrants for the purchase of common stock of each GSE representing 79.9% of the common stock of each GSE on a fully-diluted basis at a nominal price


The following covenants apply to the GSEs as part of the agreements.

o Without the prior consent of the Treasury, the GSEs shall not:

  • Make any payment to purchase or redeem its capital stock, or pay any dividends, including preferred dividends (other than dividends on the senior preferred stock)
  • Issue capital stock of any kind
  • Enter into any new or adjust any existing compensation agreements with “named executive officers” without consulting with Treasury
  • Terminate conservatorship other than in connection with receivership
  • Sell, convey or transfer any of its assets outside the ordinary course of business
    except as necessary to meet their obligation under the agreements to reduce their portfolio of retained mortgages and mortgage backed securities
  • Increase its debt to more than 110% of its debt as of June 30, 2008
  • Acquire or consolidate with, or merge into, another entity.

7 Responses to “Fannie & Freddie Plan Released: Treasury Follows PrefBlog's Plan!”

  1. lystgl says:

    You know I expected the $US to drop like a stone today. It didn’t. I expected oil, because of the drop in the $US, to go up rather dramatically. It didn’t. The taxpayer in the US has just taken on an additional 5.3 trillion dollars in debt with the government takeover of Fannie and Freddie. This should have given everyone pause, but no, the market(s), TSX notwithstanding, all go up like it’s Christmas. Ich verstand nicht!!

  2. jiHymas says:

    The taxpayer in the US has just taken on an additional 5.3 trillion dollars in debt with the government takeover of Fannie and Freddie.

    Well … this particular debt has something behind it, namely prime mortgages, mainly. It wasn’t just spent-n-gone.

    The other thing is the degree to which the market has already priced things in; I suggest that the market was pricing in some chance of a Fannie/Freddie default (utterly catastrophic, right now) vs. some chance of the US hitting the wall on debt at some yet-to-be-determined time in the future (also utterly catastrophic, but this comes later). Net-net, Armageddon has been delayed.

  3. lystgl says:

    There’s a school of thought out there that the true value of the properties on which Fannie and Freddie hold mortgages, is about half of that stated. Remember, WaMu was accused of inflating values, and if they were doing it, so were countless others. If so, that still puts them “on the hook” for about 2.6 trillion. They’ve got to put the printing presses on uber high and inflation has to go postal. Nothing else for it. Armageddon delayed perhaps, but not for long, I’m thinking.

  4. jiHymas says:

    If so, that still puts them “on the hook” for about 2.6 trillion.

    Well … not really, because most of these things (most!) are prime mortgages. Table 41 of Fannie’s 2007 Annual Report shows a weighted average 75% original loan-to-value and 61% weighted average mark-to-market loan-to-value.

    I haven’t done any work at all on their financials, so this is a mere factoid, but my point is that the borrowers are still right-side-up on their mortgages … at least until housing prices decline a lot more!

    The gloomiest forecast I’ve seen is:

    “Some of this is a stopgap to try to prevent the mortgage market from falling apart,” former Federal Reserve Bank of St. Louis President William Poole said on Bloomberg Radio. The federally chartered, shareholder-owned structure, with risks covered by taxpayers, is “an unacceptable situation,” he said, projecting the Treasury may need to cover as much as $300 billion of losses.

    $300-billion? A mere bagatelle. Colonial skirmishes in the Middle East cost more than that.

  5. lystgl says:

    From an article in BusinessWeek, “one of the stated reasons for the Freddie and Fannie takeovers was an audit that showed losses at the mortgage financiers were much worse than previously stated.”
    Bear Sterns, with government blessings, wiped out the shareholders over the weekend giving them no opportunity or recourse, and here we go again (over the weekend) with government being even more overt. Getting difficult to distinguish the good old US of A from Chavez’s Venezuela, Putin’s Russia, or going back a little further, Castro’s Cuba. Their dollar should be tanking and investors should be nervous. Who are they going to nationalize next?

  6. […] 2008-9-9: An interesting nuance has arisen as a result of the Fannie/Freddie Fiasco: the structured preferred share issue RPB.PR.A has a recovery lock of 40% on its GSE exposure […]

  7. […] was pleased when Treasury took my advice regarding the structuring of the GSE rescue, but they didn’t follow my instructions of […]

Leave a Reply

You must be logged in to post a comment.