Events surrounding a potential bail-out of Fannie & Freddie, which started picking up speed after Friday’s close, appear to be nearing a crescendo.
The New York Times reports (hat tip: Financial Webring Forum) that Freddie Mac overstated capital:
The methods used to bolster that cushion have caused serious concerns among the companies’ regulator, outside auditors and some investors. For example, while Freddie Mac’s portfolio contains many securities backed by subprime loans, made to the riskiest borrowers, and alt-A loans, one step up on the risk ladder, the company has not written down the value of many of those loans to reflect current market prices.
Executives have said that they intend to hold the loans to maturity, meaning they will be worth more, and they need not write down their value.
…
Freddie Mac and Fannie Mae have also inflated their financial positions by relying on deferred-tax assets — credits accumulated over the years that can be used to offset future profits. Fannie maintains that its worth is increased by $36 billion through such credits, and Freddie argues that it has a $28 billion benefit.But such credits have no value unless the companies generate profits. They have failed to do so over the last four quarters and seem increasingly unlikely to the next year. Moreover, even when the companies had soaring profits, such credits often could not be used. That is because the companies were already able to offset taxes with other credits for affordable housing.
This sounds totally disingenuous to me. These accounting concerns are old news; the regulators would not be in least surprised to find them on the books, they’d just pretend it was horrible startling news.
Time Business & Economics columnist Justin Fox muddies the waters with disinformation:
But what about the shareholders? It seems only fair that if the government has to step in to take over the companies, shareholders should lose everything. Except that there’s a big complication: Lots of small and mid-sized banks in the U.S. have, with encouragement from regulators, built up big holdings in Fannie and Freddie preferred stock, which they use to satisfy their capital requirements. If Fannie and Freddie preferred shares become worthless, a lot of banks will become insolvent.
However, there is one redeeming feature to that post: he quotes his source, who did not say that. :
However, the government made Fannie and Freddie preferred stock a “permissible” investment to create a sufficiently large market for these securities.
Of course, making the stock “permissible” didn’t necessarily make it attractive, so regulators had to pull another trick. Under the risk-based capital rules, national banks may carry agency preferreds at a 20 percent risk weighting (pdf file), while state-chartered banks and OTS-regulated savings associations must apply a 100 percent risk weighting. This means that banks only have to hold 1.6% or 8% capital against their investments (or should we say ‘speculation’?) in Fannie and Freddie preferred stock.
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Thomas Kirchner is long FNM. He manages the Pennsylvania Avenue Event-Driven Fund [PAEDX], which is long and short various FNM and FRE securities. He is a former FNM employee.
Mr. Kirchner in turn cites the OCC Publication “Activities Permissable for a National Bank”:
Fannie Mae and Freddie Mac Perpetual Preferred Stock. A national bank may invest in perpetual preferred stock issued by Fannie Mae and Freddie Mac without limit, subject to safety and soundness considerations. OCC Interpretive Letter No. 931 (March 15, 2002).
It should be noted that there is nothing in the cited document to support the assertion of 20% risk weight … PrefBlog’s Assiduous Readers, however, will have read my post Fannie Mae Preferreds: Count Towards Bank Capital? in which some support for the 20% risk-weight figure was unearthed.
Naked Capitalism linked to a John Dizard column in the Financial Times:
Last week I wrote about these preferreds; my position was that if or, rather, when the Treasury had to recapitalise the GSEs with new, senior preferred issues, it would be a really good idea from the taxpayers’ point of view to leave the old preferreds in place while wiping out the value of the outstanding common stock.
… which is not inconsistent with the solution I see as best, but his original column was not very specific:
Still, to the point raised by Peters and the other cautionary voices, there are answers. First, Fannie Mae and Freddie Mac need to be nationalised, in the sense that the federal government injects capital in the form of preferred equity and direct credit support, wiping out the existing common. I believe it is critical that that takeover leaves the privately held preferred stock of the government-sponsored enterprises in place. Preserving the value of GSE preferred issues is very much in the taxpayers’ interest, as it makes possible the recapitalisation of the rest of the banking system.
Very interesting, but just macro-style generalities.
However, the Wall Street Journal has reported:
U.S. Treasury Secretary Henry Paulson and Federal Housing Finance Agency Director James Lockhart are expected to release details of the planned conservatorship of Fannie Mae and Freddie Mac at an 11 a.m. press conference in downtown Washington.
More when I know more …
Update: See Fannie & Freddie Plan Released: Treasury Follows PrefBlog’s Plan!
Makes one wonder – is our CMHC, behind a year or two year like everything else Canadian, to suffer the same fate? They recently retracted their forty year and zero down “flex” mortgage insurance. (copied directly from their US counterparts) You could hope this was astuteness on their part – given what we’re seeing down south, but is it more serious than that?
is our CMHC, behind a year or two year like everything else Canadian, to suffer the same fate?
All I can say is … I doubt it. Canada has not seen anywhere near the same kind of real-estate speculation that got the States into this mess and has generally had much tighter mortgage requirements to boot. In Canada, Loan-to-Value ratios have been lower, there is recourse to the borrower on default and most mortgages are issued with a 5-year term.
Getting rid of zero-down mortgages was a Good Thing in my book, but the elimination of forty-year amortization was of limited utility.