FYI | Aug 21 2008
By Greg Peel
“They haven’t asked for anything and we haven’t offered anything,” noted Fannie Mae CEO Daniel Mudd in a radio interview last night, in reference to the US government. “I don’t anticipate they’ll do that”.
Strange. Last month the Bush Administration announced a plan to aid the two mortgage lenders – responsible for US$5trn or half of all US mortgages – should they need it. Treasury Secretary Paulson offered to do “whatever it took” to save the two. Apparently he must have made this offer in a vacuum, if Treasury never asked for anything. Associated Press’s Stephen Bernard and Alan Zibel maintain they have leaked information that claims both Freddie and Fannie have had regular meetings with the Treasury department over the course of the month, which is exactly what one might expect under the circumstances.
What do they talk about? The Olympics?
So Mudd doesn’t anticipate the Treasury will ask for anything. Perhaps Paulson will just watch the two lenders’ stock prices descend to zero over a beer and a hot dog. Under the circumstances, this seems like an extremely disingenuous statement, at best.
Freddie Mac CEO Richard Syron continues to maintain his company has more capital now than it has ever had. Whether or not this may be true, is this statement not misleading? Freddie (and Fannie) shares fell about another 25% last night, to be down 40% in a week and over 90% from their highs. Between April and June the two wrote down a collective $3.1bn on mortgage values. Freddie promised earlier in the year to raise another US$5.5bn in capital. On last night’s share price close, its market cap is now US$2.1bn. According to the Wall Street Journal, between them Fannie and Freddie have US$223bn in bonds they have to pay back before the end of the quarter.
The twins do not hold subprime mortgages. They hold only prime mortgages on houses of less than half a million dollars in value. But foreclosure rates on such mortgages have leapt enormously, and that’s why the twins are in trouble. On Tuesday, Freddie made a regular offering of five-year notes to the market (this is how it funds its mortgages) and had to pay 113 basis points over Treasury notes. This is meant to be AAA paper. In May, Freddie was paying 69 points over.
Clearly the market is pricing in a risk that may or may not be built on hype and fear, or the exploitation of hype and fear. This is often how things snowball. But for the two CEOs to carry on as if everything’s fine and life couldn’t be better is scurrilous. The Bear Stearns CEO was the most recent in a long line to make such a claim, one day before Bear Stearns went under.
The snowball is rolling and will likely not be stopped. The expectation is that if the government does step in to prop up equity it will do so by buying preferred stock, which rates higher than common stock. Common stock holders would thus be shut out and their shares rendered worthless. That’s the market – caveat emptor. It’s also why the shares of both are down 90%.
But why are the shares still trading? If the CEOs were to come out and speak the truth – yes, we’re in some difficulty but we’re working on it – then perhaps the share prices might fall. But they’re falling anyway because no one knows what’s going on. The market knows the Treasury is in desperate talks with Fannie and Freddie, but the CEOs are denying it. The government is saying nothing. Is this a free market of full disclosure?
Armando Falcon served for six year’s as the twins’ chief government regulator. He told AP he expected a full government takeover by year-end. The companies’ financial picture is far worse than they’re letting on, he suggested. “They can’t keep playing games with the accounting rules to avoid taking their losses”.
Why not? – the cynic might ask. Everyone else is.
Whatever is about to transpire, it appears the script is already written. Shares in the two lenders are now down to penny-dreadful level. The only traders left buying are covering shorts. Perhaps this is what the government actually wants to happen. They’re probably saddling Paulson’s white charger as we speak. It’s easier to screw a lot of shareholders out of a couple of dollars and call it a market, rather than step in with the shares a lot higher and call it intervention.
