What Is The Truth? (Fannie/Freddie)

Wow.

Ok, so you saw my rant-rage on Fannie and Freddie and Bloomberg's report this afternoon.

Well, just a bit ago, this came across:

"Under the plan, the federal government would place the firms in a legal state known as conservatorship, the sources said. The value of the company's common stock would be diluted but not wiped out while the holdings of other securities, including company debt and preferred shares, would be protected by the government."

....

"The chief executives of the two companies were called into afternoon meetings today at the 17th Street NW offices of the Federal Housing Finance Administration, their direct regulator, according to sources familiar with the events.

Executives of the two companies were told to show up without being told of an agenda. Daniel Mudd, chief executive of Fannie Mae, was accompanied by outside lawyers. He showed up at around 3 p.m. for a two hour meeting. Richard Syron, chief executive of Freddie Mac, started his meeting at around 5 p.m., accompanied by several members of the Freddie Mac board."

This is very different from what Bloomberg reported.

This, in fact, is effectively an involuntary bankruptcy petition.

Now think about this one folks. 

Under HR.3221 and the previous enabling legislation for OFHEO, in order for the government to step in they must first declare these firms critically undercapitalized.

Now just a couple of weeks ago, we heard Fannie's CEO Mudd tell us that the firm has more capital now than at any other time in its history, and that it is comfortable above minimum capital requirements.

Freddie also stated they were well-capitalized.

So what happened here, exactly?

Three possibilities, all nightmares:

1. The firms both burned through all of their excess reserves and capital in the last few weeks.
2. There was some "event" that was about to happen - like over the weekend - that would have caused the firms to be unable to operate (e.g. someone, perhaps the Chinese, said they were going to intentionally tank GSE paper as an act of economic warfare?)
3. The audit being done by Morgan and Deloitte and Touche found critical misstatements in the firm's capital structure, perhaps similar to what happened back in the early part of the decade when they were caught "cooking the books", and as such what they claimed to have wasn't really there!

There is no other explanation that makes sense.

Now tell this is "bullish" for the market.

How does any of the above scenarios constitute a "buy" for financial stocks - or anything else?

There is much flying about on the news wires this evening on this "bailout" and the specifics, and the distinctions are important.  Here are some of the paragraphs:

NY Times:

"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."

Note that (1) both common and preferred are essentially wiped out, and (2) the word could in the guarantee of existing debt.

Washington Post:

"Under the plan, which could prompt one of the most sweeping government interventions in the workings of financial markets in U.S. history, federal officials would place the firms under a conservatorship, a legal status giving the government the option and time to restructure and revive the companies, the sources said. The value of the companies' common stock would be diluted but not wiped out; while the holdings of other securities, including company debt and preferred shares might be protected by the government."

Wait a minute.  Might be protected?  Look at the top of this Ticker.  That first quote is the same paragraph from the same source but earlier it read:

"Under the plan, the federal government would place the firms in a legal state known as conservatorship, the sources said. The value of the company's common stock would be diluted but not wiped out while the holdings of other securities, including company debt and preferred shares, would be protected by the government."

Hmmmmm... maybe someone from Treasury or The Fed saw that would and made a phone call?

Now here's the set of problems, as I see it.

1. Placing the firms into conservatorship (effectively Chapter 11 bankruptcy for them, "prepackaged") is fine.  In fact, it needed to happen a couple of years ago.  That's the good news.
2. Running down the firms' portfolios is both a good idea and is necessary.  We simply cannot have these firms play "hedge fund", and it is clear that the only way to stop it is to strip them of the ability to do so.
3. These firms bought, intentionally, nearly one trillion dollars between them of subprime and "ALT-A" no-doc or reduced-doc mortgages.  These are not prime loans, they are loans made to speculators, and they are the ones most at risk!  We must not and cannot bail these people out.
4. Guaranteeing the existing debt of these firms, which was sold with a black-letter statement on the front of every single prospectus, is unacceptable and exposes the United States Taxpayer to the full $5 trillion in debt that these firms hold and control.  This is equal to the entire public float of The United States Treasury and more than 1 trillion of it is in the hands of foreign central banks in nations such as China and Japan.  They bought this debt with the full knowledge that it was not guaranteed.
5. There is every reason to believe that Treasury Bond Yields will shoot higher in the coming weeks and months.  If this happens it will "take back" any benefit from this so-called "bailout" immediately, and worse, it will hike borrowing costs across the economy - not just in housing - when we are already in a credit crunch.  The result of such an event could be disastrous and it is what I have been warning about for months.

I stand behind my earlier Ticker; this is an outrage.

John McCain, if you are reading this and you really meant any of your speech when accepting the Republican nomination, you need to stand up right here and now and put a stop to this crap, making clear that you will NOT permit it under your administration and will "unwind" anything that encumbers the taxpayer with this garbage paper prior to your taking office, assuming you win.

Barack Obama, you said that these firms were "weird" and that if they were to be public firms they cannot be backstopped, and if government-run, they cannot make profits.  Well?  Where is YOUR outrage?

We have two Presidential Candidates and this is the issue for November folks. 

You can claim all you want that we should have an election about The War, about national security, about health care or about energy independence.

None of this matters if our economy and government funding mechanisms are damaged or destroyed due to the irresponsible and outrageous bailing out of TWO GIANT HEDGE FUNDS that happen to be called "Fannie Mae" and "Freddie Mac", and THE PRESENT GOVERNMENT just took FIVE TRILLION DOLLARS onto its balance sheet!

You're worried about Medicare, Social Security, our nation's infrastructure, or our energy needs?

Well what the HELL are you doing then sitting on your butt this weekend sirs, while UNELECTED Ben Bernanke and Hank Paulson TAKE FIVE TRILLION DOLLARS WE DON'T HAVE, FIVE TIMES THE AMOUNT WE HAVE SPENT IN TOTAL ON THE IRAQ WAR, AND BLOW IT ON BAILING OUT TWO GIGANTIC HEDGE FUNDS AND THEIR "INVESTORS"?

GET OUT IN FRONT OF THIS ISSUE NOW - THIS WEEKEND - IF YOU WANT AMERICAN'S VOTES!