Fannie and Freddie: Another Bailout That Leaves Shareholders Starving
If there is little market confidence in U.S. financial institutions right now, maybe this is why: government bailouts of banks this year have left shareholders high and dry.
Before the Asian markets opened Monday, Treasury Secretary Hank Paulson announced that his agency would bail out struggling Fannie Mae and Freddie Mac, which together guarantee nearly $5 trillion in American mortgages but have a fraction of that amount in available capital.
Fannie and Freddie combined, which own or guarantee roughly $5.2 trillion of U.S. home mortgages, have capital cushions of only $81 billion and just $2.25 billion each in credit lines from the Treasury. Paulson proposed increasing those credit lines, auctioning off $3 billion in Fannie and Freddie debt, and potentially even buying some equity in the struggling home lenders, at the risk of diluting current shareholders. The move was ostensibly to put a tourniquet on the bleeding in their shares: Fannie Mae shares tumbled 55% last week and Freddie Mac fell 70%, leaving both at roughly 16-year lows.
Paulson was very specific that one group of people should see none of the Treasury’s money: Long-suffering Fannie and Freddie shareholders.
Here is how our colleagues summarized Paulson’s objection in the article linked to above: “Mr. Paulson does not want to help the shareholders because of the ‘moral hazard’ it would create–desensitizing investors to risk because they believe the government will bail them out. It’s a similar position he took during the government-orchestrated rescue of Bear Stearns by J.P. Morgan Chase & Co.”
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After all, it doesn’t seem a very strong defense for the government to say, “you should have known better than to have confidence in Fannie Mae and Freddie Mac.” The government’s involvement was precisely why any shareholder would have faith in Fannie and Freddie. They are, after all, “government-sponsored enterprises,” or GSEs. Paulson used the term — but did not define it — in his statement yesterday.
Consider the uncomfortable truth here: shareholders bought shares of Fannie and Freddie precisely because they knew that if the two lenders ever fell in trouble, the government would step in. And now that the government has stepped in, it is determined not to help shareholders, saying they should have known better. Well, did the government know better? And if so, why didn’t it take action earlier?
After all, shareholders didn’t mismanage Fannie Mae and Freddie Mac through accounting scandals; management did, aided and abetted by lax regulatory oversight that ignored warning sign after warning sign. Yes, there is the risk that all equity owners take — but the equity risk for the average public company may be different when the company in question has its board and management approved by our Congress. Given that context, Fannie and Freddie’s troubles are sui generis. The two lenders have been investigated for appraisal fraud, accounting problems and inappropriate compensation for their executives.
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