Today US Treasury Secretary Henry Paulson announced plans for the new Federal Housing Finance Agency (FHFA) to take Freddie Mac and Fannie Mae into conservatorship. The power to do this was provided in HR 3221 which was passed in July.
The move includes replacement of the CEO of both organizations, and an infusion of about $200 billion. In return, the Treasury gets $1 billion in preferred stock from each company without providing the cash for it up front (I’m assuming this will work like a stock option).
From the Wall Street Journal:
It is unclear how much the government’s intervention will ultimately cost taxpayers. In exchange for agreeing to provide as much capital as needed to the companies as they cope with heavy losses on mortgage defaults, the Treasury will acquire $1 billion of preferred shares in each company. It has obtained warrants that give it the right to a stake of 79.9% for a nominal sum. The Treasury’s preferred shares will be senior to those earlier issued, meaning the government will have the first right to receive dividends.
The new overseers will also eliminate dividends on billions of common and preferred stock, moves that are expected to drive down the price of those shares, which have already dropped precipitously this year. The issue of additional preferred shares will dilute common shares.
And now the government gets to cover the bad debt, which means you and I cover the bad debt, and presumably the dividends from the preferred stock will go into the treasury.
Although I recognize the fact that the potential of these companies failing would have a devastating affect on the US and world economies, the deal smells to me.
First of all, the exiting CEOs are both getting a fairly tidy compensation package. I think that’s just bonkers. They suffer no real loss over their failings, especially in the light of the Alt-A loans debacle. These loans were treated somewhere between prime and sub-prime loans and, get this, didn’t require the same level of documentation as you and I have to provide for income and assets on our mortgages. These guys should have been shown the bomb-bay door with no parachute.
I don’t trust the fact that a new source of revenue is being created so that Congress can use it to spend more money it doesn’t have, money that really belongs to us, that we’re going to pay up front to cover the bad debt incurred by the bad loans made at these companies.
I don’t want to kill our economy, but I also don’t like propping up investors who are always warned boldly that “investments involve risk”.
And lastly, I don’t like seeing our government get any bigger. The role of government should not be to get itself into the world of business. First we start competing with banks with the faux tax credit ($7,500 for new home buyers that is treated like a tax credit but is really an interest free loan). Now we take control of the 2 biggest mortgage owners in the country. Which means, the government now owns your house AND collects taxes from you on it.
This will be a major balancing act as long as this authority is in place. Between the mortgages, property taxes (I can just see the fights between the Fed and counties), the taxpayers getting squeezed, the proper handling of the income from the preferred stocks, working out the long term strategy (which will be left for the next congress and president). We’ve become too scared of the risk of financial failure to ever really allow the market to run its course.
The logical end of this seems to be government controlled banking and investing. I’m sure that will kill our growth and cripple our relative power in the global economy.
As I’ve said in the past, I am not a professional economist.
This really may have been the only and best thing that the government could do. I’d just like someone to show me why.