Saturday, September 06, 2008

Feds bail out Fannie Mae and Freddie Mac

It is time to get away from the political news and talk about some economic news. From The New York Times:

WASHINGTON — Senior officials from the Bush administration and the Federal Reserve on Friday called in top executives of Fannie Mae and Freddie Mac, the mortgage finance giants, and told them that the government was preparing to place the two companies under federal control, officials and company executives briefed on the discussions said.

The plan, which would place the companies into a conservatorship, was outlined in separate meetings with the chief executives at the office of the companies’ new regulator. The executives were told that, under the plan, they and their boards would be replaced and shareholders would be virtually wiped out, but that the companies would be able to continue functioning with the government generally standing behind their debt, people briefed on the discussions said.

It is not possible to calculate the cost of any government bailout, but the huge potential liabilities of the companies could cost taxpayers tens of billions of dollars and make any rescue among the largest in the nation’s history.

The drastic effort follows the bailout this year of Bear Stearns, the investment bank, as government officials continue to grapple with how to stem the credit crisis and housing crisis that have hobbled the economy. With Bear Stearns, the government provided guarantees, and the bulk of its assets were transferred to JPMorgan Chase, leaving shareholders with a nominal amount.

Under a conservatorship, the common and preferred shares of Fannie and Freddie would be reduced to little or nothing, and any losses on mortgages they own or guarantee could be paid by taxpayers. Shareholders have already lost billions of dollars as the stocks have plunged more than 80 percent this year.

A conservatorship would operate much like a pre-packaged bankruptcy, similar to what smaller companies use to clean up their books and then emerge with stronger balance sheets. It would allow for uninterrupted operation of the companies, crucial players in the diminished mortgage market, where they are now responsible for nearly 70 percent of new loans.

The executives were told that the government had been planning to announce the decision as early as Sunday, before the Asian markets reopen, the officials said.

During the housing bubble heyday, banks and mortgage companies were pushing subprime loans to anyone who wanted them, regardless of credit. These subprime loans were repackaged into mortgage-backed securities to be sold to investors, who, in their incessant greed, felt that the market would forever increase. In other words, there was rampant speculation within the market. But when it became clear that the subprime homeowners could not pay the higher interest costs on their loans, the bubble crashed, banks were left with foreclosed homes that they could not sell to recoup the losses of their subprime loans, and the investors holding the mortgage-backed securities had no clue as to the true value of the homes listed in their securities. Fannie Mae and Freddie Mac control about $5 trillion in mortgages. Central banks and investors holding the $5 trillion are worried that the mortgage giants will not be able to guarantee their securities, backed by the falling home values. It is a snowball effect, tearing through the mortgage industry that issued the subprime loans, the banks putting up the money for the loans and then repackaging them into the investment securities, and finally going through the financial institutions, Fannie Mae and Freddie Mac, in selling these securities to investors.

And now, the U.S. taxpayer is picking up the tab for the incessant greed that led us into this mess.

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