And, if this is still the right time to throw a flood of liquidity to the housing market (but with reasonably conservative debt service capacity tests on the borrowers, forget about the loan to value ratios, no one knoew what value is in a market like this), people interested in moving or buying cheap can be accomodated and markets not in severe distress may be saved. That is the way to use taxpayers money here.

Of course everyone would like to see punitive action against moral hazard artists, but in this case, probably, this is all that was on the table for the gvt as a quick fix, in order to avoid lengthy legal battles and contagion of the severe market failure conditions to as yet relatively healthy markets. It is the best an outgoing administration can do without alienating its own fans. My main criticism is that it significantly narrows the policy options for an incoming administration. But it appears to save time, and that may be more important right now. If the price decline can be arrested at the national level (severely distressed markets still needing a lot of time) that may crate benefits that will dwarf the cost to the taxpayer. And, so far the taxpayer has not given a penny. We are talking about loans and a small amount of preferred stock. If this stabilizes the housing market, any definitive losses to the taxpayer will be dwarfed by the wealth effect of housing..

I

+++++++++
Treasury Secretary Paulson GSE Program announced September 7:

Jim Lockhart, Director of the new independent regulator, the Federal Housing Finance Agency (FHFA), places GSEs in ‘conservatorship’ and replaces CEOs and board members–> “GSEs will no longer be managed with a strategy to maximize common shareholder returns.”

4 Step Program:

1) To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off

2) Treasury and FHFA have established Preferred Stock Purchase Agreements: Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, common and preferred shareholders bear losses ahead of the new government senior preferred shares. Conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses–>” while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital.”

3) Establishment of a new secured lending credit facility for GSEs incl. FHLB, intended to serve as an ultimate liquidity backstop (temporary authority expires in December 2009)

4) Treasury is initiating a temporary program to purchase GSE MBS starting later this month–> Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains (temporary authority expires in December 2009).

–> The Preferred Stock Purchase Agreements minimize current cash outlays, and give taxpayers a large stake in the future value of these entities. In the end, the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward.

–> Before Treasury’s temporary authority expires in Dec 2009, Congress must decide about a long-term solution. Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes. And policymakers must address the issue of systemic risk.
# Lockhart (OFHEO): At the end of March, F&F had credit outstanding of $5.3 trillion, including agency debt of $1.6 trillion and guaranteed mortgage-backed securities (MBS) of $3.7 trillion. By Q1 2008, FannieMae ‘fair value’ Tier 1 capital ratio at 0.4%, and -0.2% for FreddieMac.
# OFHEO: Of the $314 billion of private-label securities (PLS) held by the Enterprises at the end of 2007, approximately $217 billion were backed by subprime and Alt-A mortgages–> PLS backed by subprime mortgages represented 9.2% of the Enterprises’ combined mortgage portfolio assets, securities backed by Alt-A mortgages represented about 5.8% of their combined mortgage portfolio assets.
# Most of $36bn preferred shares is held by banks and insurers that have already written down over $500bn (FT via InvestorsInsight)
# cont: : There is $36 billion in preferred shares as of June 2007. Then there is $19 billion in subordinated debt. These firms back $5.2 trillion in mortgage securities, that means even a 1% loss from foreclosures would mean a $50 billion portfolio loss. Adding this up, a bail-out might cost at least $105 billion, not the $25bn as envisaged by CBO.
# cont: There are $62 trillion (with a “T”) in credit default swaps written against Fannie and Freddie debt, or somewhere near 12 times the actual debt–> depending on how the “credit event” is characterized, it may allow the seller of the insurance to postpone payment for five years.
# Brad Setser (CFR): Foreigners (mostly central banks but also big Japanese banks and the bank of China) hold over 20% or $1.3T of the outstanding long-term debt of U.S. government agencies. China and Japan are the largest holders with $376b and $229b respectively–> foreign central banks turned into agency debt net sellers for the first time as spreads kept widening.
# Ingo Walter: it is critical that the government obtain warrants or rights equal to the full and fair value of this subsidy and any upside that this support generates (similar to those received in the 1980 Chrysler bailout). It is critical to minimize costs to the taxpayers and to assure that the value of any support accrues to taxpayers and not to management, shareholders or debt holders.

“These firms back $5.2 trillion in mortgage securities, that means even a 1% loss from foreclosures would mean a $50 billion portfolio loss. Adding this up, a bail-out might cost at least $105 billion, not the $25bn as envisaged by CBO.”

The mortgage bankers assc. just reported 9% of mortgages are either foreclosed on or behind in payments.

The gov just announced a Federal deficit estimate for next year of $480B plus $90B in off budget war spending.

The economy is not in recession yet according to the government. But if it does go into recession, these things get worse.

I also see geological problems with nationalizing F&F. If they ever get The Big One in California, the government is wiped out and we will have to close down the country.

And the ultimate question in my mind is, if the mortgage stuff was insured already by Credit Default Swaps, why is the taxpayer still insuring it? $62 trillion in insurance is not enough?

“There are $62 trillion (with a “T”) in credit default swaps written against Fannie and Freddie debt, or somewhere near 12 times the actual debt–> depending on how the “credit event” is characterized, it may allow the seller of the insurance to postpone payment for five years.”

I think you are being disingenuous about the US responsibility for its debts:

(1) True, the US never undertook to maintain the external value of the dollar, but the Fed undertake to maintain its internal value, and the two are cointegrated.

(2) The total amount of debt owed by the US government to foreign countries is large, but less than the typical US family might take on to buy a house. The point is that the US has the ability to pay. The problem is, in the first instance, the honesty of its politicians to tell its people the truth about their situation, and secondly, their willingness to bear the burden.

Good to have the numbers close by. Final details of the plan not out yet, but it looks like the bonds may stay the same, but include a taxpayer pass thru to make up any interest shortfall in the portfolio.

Still no word how they get cash to make new loans. Won’t make the collateral re-flate either.

Next we will find out what it was that Greenspan liked about derivatives. There’s 62 Trillion of those, whatever they are.

We still need a nick name for the bonds. I propose either Big Macs, or perhaps White Dwarfs.

——————————————-
Key features of government intervention (final deal to be announced before Asian markets open):
1) Fannie and Freddie and their combined $1.6 trillion investment portfolio business financed through agency bond issuance will be taken under a government-run conservatorship for an orderly restructuring process–> new housing law says that under a conservatorship, the authorities would aim to preserve Fannie and Freddie assets, rather than dispose of them.
2) 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 likely to be protected by the government. (Washington Post)
3) taxpayer backstop for combined $5.3 trillion F&F owned or guaranteed debt: taxpayer funds will be used to pay any cash-flow shortfalls (e.g. due to borrower defaults) on mortgages F&F own or guarantee;
4) capital infusions to F&F in conservatorship on a quarterly basis depending on reported results instead of large capital infusion upfront;
5) Fire CEOs and replace the board
# compare with new William Ackman proposal sent to Treasury on Sep 5: “In the event the government needs to inject capital immediately, we suggest that the Treasury consider purchasing senior subordinate debt in the two companies in an amount sufficient to address their capital needs in the short to intermediate term. All of the outstanding sub debt, preferred and common stock would continue to remain outstanding according to their existing terms.”–> see overview of original plan
# Majority of $36bn preferred shares is held by small and regional banks and other financial institutions, incl. insurers, that have already written down over $500bn (FT via InvestorsInsight)
# cont: : There is $36 billion in preferred shares as of June 2007. Then there is $19 billion in subordinated debt. These firms back $5.2 trillion in mortgage securities, that means even a 1% loss from foreclosures would mean a $50 billion portfolio loss. Adding this up, a bail-out might cost at least $105 billion, not the $25bn as envisaged by CBO.
# Of the $314 billion of private-label securities (PLS) held by the Enterprises at the end of 2007, approximately $217billion were backed by subprime and Alt-A mortgages. At year’s end, PLS backed by subprime mortgages represented 9.2% of the Enterprises’ combined mortgage portfolio assets, securities backed by Alt-A mortgages represented about 5.8% of their combined mortgage portfolio assets.
# cont: There are $62 trillion (with a “T”) in credit default swaps written against Fannie and Freddie debt, or somewhere near 12 times the actual debt–> depending on how the “credit event” is characterized, it may allow the seller of the insurance to postpone payment for five years.
# Brad Setser (CFR): Foreigners (mostly central banks but also big Japanese banks and the bank of China) hold over 20% or $1.3T of the outstanding long-term debt of U.S. government agencies. China and Japan are the largest holders with $376b and $229b respectively–> foreign central banks turned into agency debt net sellers for the first time as spreads kept widening.
# Lockhart (OFHEO): At the end of March, F&F had credit outstanding of $5.3 trillion, including agency debt of $1.6 trillion and guaranteed mortgage-backed securities (MBS) of $3.7 trillion. By Q1 2008, FannieMae ‘fair value’ Tier 1 capital ratio at 0.4%, and -0.2% for FreddieMac. The companies’ capital is leveraged 50 times.
# Ingo Walter: it is critical that the government obtain warrants or rights equal to the full and fair value of this subsidy and any upside that this support generates (similar to those received in the 1980 Chrysler bailout). It is critical to minimize costs to the taxpayers and to assure that the value of any support accrues to taxpayers and not to management, shareholders or debt holders.

Was wondering something else.

Do you think the Economist magazine will come up with a Big Mac index that adjusts the new F&F bond prices for Purchasing Power Parity?

“Cedric — a nationalized company would issue bonds that would be considered almost as good as treasuries, so it likely would have no trouble rolling over its debt. the agencies creditors would assume that any losses on the agencies underlying portfolio would be assume by the taxpayer, not shifted to bondholders.”

So….they will issue F&F bonds that are almost explicitly guaranteed?

I didn’t know the US settles its debts in FX.

Sure there are problems, but the question is are things better or worse. You will never have a perfect economic system, and there always been be problems, the question is whether you have more serious problems or less serious problems, and the problems that the Chinese economy faces today are less serious than the ones that existed ten years ago.

Yeo: Have all soe turned private organisations really made that transition smoothly?

No. It wasn’t a smooth transition at all. Laying off several tens of millions of workers is messy, and the companies that exist now are hardly models of economyic efficiency. However, the worst SOE’s have been closed.

Yeo: that NPL problem has not been fully resolved, sweeping things under the carpet hardly resolves matters?

It does sometimes. What you really want to see is whether delaying things helps issues or hurts things, and sometimes delaying solving a problem actually helps. In the case of the SOE’s the first priority was to stop the bleeding and this was done in 1998. At this point the banks stopped loaning SOE’s new money. Once you have stopped the bleeding, then in the Chinese situation it makes sense to delay resolving the problem for as long as possible. If you delay the problem then each year you have more money (10% GDP growth) and deeper institutions that make resolving the problems easier as time goes by.

There is an American bias toward sudden dramatic changes that purport to fix everything. Sometimes a “big bang” solution is a good idea since delaying fixing the problem will make the problem worse. Often it isn’t. The fact that you aren’t solving every problem *right now* doesn’t mean that you are ignoring it.

Yeo: when faced with real disaster, logic rarely wins against anger and frustration. particularly when the problem is seen as having a foreign origin.

That’s why you need a plan. Plans are useless, planning is essential. What you likely will find when you are faced with a crisis for the first time, is that the plan you had in place, just won’t work and you have to do something origial. The thing about planning is that it means that you have some of the tools and people in place to do the new original thing, and most importantly it means that you’ve spent several months “thinking the unthinkable.”

Organizationally if the senior management doesn’t want you to think about something, then you really can’t organizational prepare for it. Planning for something means that you have permission to think and talk about an issue in a bureaucracy, and making something “not internally taboo” is vitally important in a bureaucracy. Bureaucracies always try to smile to reporters and outsiders, but the important thing is whether they can talk about something internally.

The reason that the government started worrying about the banking system was the fall of Suharto in Indonesia as a result of the Asian Crisis. Once the Party realized that a collapse of the banking system could destroy the Party, then this become a very high priority issue to resolve.