Fortune magazine and the N-word

by John Quiggin on July 10, 2008

Nationalization, that is. In this piece on doomsday scenarios for Fannie Mae and Freddie Mac (H/T Calculated Risk) the cutely named and quasi-private mortgage packagers and guarantors, Katie Benner says

So what might it look like if the government had to lend a hand? Outright nationalization is an unlikely option given that neither the current administration nor the presidential candidates could afford to support such a move in an election year.
but goes on to imply that the likely alternatives could be far more costly, citing a Standard & Poors estimate of a trillion dollar cost to taxpayers, and possible loss of the US government’s AAA rating. Agency ratings aren’ t reliable indicators, but the US government has been in the category of issuers who are assumed to be exempt from scrutiny. A change in this status would be a huge problem for a big debtor like the US.

Either a bailout or a nationalization of Fannie and Freddie would make the Northern Rock fiasco in the UK pale into insignificance. The Northern Rock case shows that a policy towards financial enterprises in which both failure and nationalization are regarded as unthinkable cannot be sustained. The shareholders of these companies have been happy to accept the higher returns associated with an implicit government guarantee and they should pay the price when the guarantee is needed.

{ 17 comments }

1

JLS 07.10.08 at 8:37 pm

Be careful, Freddie Mac and Fannie Mae are behind more than 97% of loans.
Ans since the subprime about 90 % of loans are created by these two GSE.
A bankruptcy of these two company mean the end of Real Estate at least for some years.

2

a 07.10.08 at 8:53 pm

“The shareholders of these companies have been happy to accept the higher returns associated with an implicit government guarantee and they should pay the price when the guarantee is needed.”

The shareholders ain’t nothing compared to the bondholders.

3

a 07.10.08 at 8:54 pm

“A bankruptcy of these two company mean the end of Real Estate at least for some years.”

Choose your poison. The real-estate system in America is built on a house of cards. There isn’t any solution that’s going to make it solid.

4

Walt 07.10.08 at 9:14 pm

There’s an exciting alternative to bankruptcy, one that alluded to in the post: it’s called nationalization.

5

abb1 07.10.08 at 9:44 pm

Nationalization, the way it’s done these days, is not really that exciting: rebuilding the company with public funds and then throwing it back to hyenas for next to nothing. What’s the point.

6

Bonapart O Cunasa 07.10.08 at 10:45 pm

But the implicit guarantee that Fannie and Freddie have should already be factored in to the US sovereign credit rating. It’s just not – and never has been – a credible threat to let them fail.

7

P O'Neill 07.11.08 at 1:17 am

Nuking the shareholders gets you nowhere. It’s precisely the thin capital base that is part of the problem. One of the many question for the post mortem will be how private companies ended up with such dominant positions in securitisation.

8

gandhi 07.11.08 at 1:23 am

Perhaps Alan Greenspan and his friends in the White House could be persuaded to prop up these failing companies with their own personal savings, which I believe are quite considerable.

I’m sure the board members of the Carlyle Group would be happy to provide further assistance if needed. Swell guys and true patriots, so I am told.

9

a 07.11.08 at 5:12 am

“But the implicit guarantee that Fannie and Freddie have should already be factored in to the US sovereign credit rating.”

Don’t think so. It’s a bit like saying that Enron’s off-balance sheet items were factored into Enron’s credit rating.

10

Dave 07.11.08 at 7:46 am

So do these entities have these stupid and frankly infantile names to distract the public from the fact that they represent a vast state intrusion into the market, or what?

11

Tom 07.11.08 at 6:28 pm

Technical note: US Treasury debt is not “AAA”, it is better than AAA, it is the risk-free debt that AAA and lesser quality debt is priced off of.tt

12

Joshua Holmes 07.12.08 at 1:09 am

One of the many question for the post mortem will be how private companies ended up with such dominant positions in securitisation.

Because they’re chartered by the US, and investors have (probably correctly) worked under the assumption that the US would bail them out.

13

virgil xenophon 07.12.08 at 9:21 am

For what it’s worth, most of the major players at Fannie and Freddy were Clinton appointees and it was their policy actions that set these agencies on a course of action that has ended up where we are today.

14

annie 07.13.08 at 6:41 am

realize that if fanny and freddy are taken over by the gov (they will probably be subsumed into something like ginniemae) shareholders will get nothing. stocks go to zero. it’s the bondholders (lenders) who will be paid. many pension plans, mutual funds, as well as foreign governments own these shares soon worth zero. and taxpayers will end up with the $5 trillion debt though the gov will not put it this way.
a few people have seen this coming but most politicians left and right are clueless–this includes dodd and frank, chairmen now of the banking committees. if one person should be blamed it would be serial bubble-blower greenspan, but of course the enabler was simply enabled. the pols understand nada. the banks have run amok.

15

Tom T. 07.14.08 at 12:02 am

The shareholders of these companies have been happy to accept the higher returns associated with an implicit government guarantee and they should pay the price when the guarantee is needed.

I don’t understand this point. Nationalization in this context is simply another form of insolvency workout, and that’s a risk faced by shareholders in any company. The Government guarantee doesn’t make that situation unique.

And as for the higher returns associated with the guarantee, presumably those were incorporated into the share price, so I don’t understand why those shareholders should be treated different from shareholders in any other company in that regard.

16

John Quiggin 07.14.08 at 11:15 am

I agree that there’s nothing unique about it. It’s just an obvious feature of the way in which a workout ought to proceed.

On your second para, if the benefits of the guarantee were greater than the expected cost of the implied terms of the workout when the guarantee is exercised, then the net benefit would be incorporated in the share price. So the shareholders have no reason to complain when the guarantee is called on and they are wiped out.

17

Valuethinker 07.15.08 at 2:10 pm

John

You are confusing debt and equity.

Wiping out the equity shareholders of Northern Rock, or Fannie Mae or Freddie Mac at this point will cost very little money (less than $20bn in the case of the latter 2).

The problem is the debt. 6 trillion worth, where a default could paralyse the US housing market for years, cause a run on the US dollar etc.

Now it may be that the debt holders will have to take a haircut. The debt yield did not fully reflect the risk of the enterprise.

5% say would be $300bn. But how do you ram that down the debtholders’ throats without causing a full run collapse. What if the haircut is 10% or 20%? $600bn or $1.2trn?

To add to this, you have the systemic effects. The outcome of Freddie and Fannie will have a big impact on US housing prices, and therefore the actual recoveries from their Mortgage Backed Securities. The potential for a large negative feedback loop exists. (as it does for NR– 1/12th of all British mortgages, and 1/5th of all mortgages in H1 2007).

We are in very treacherous waters. Fannie and Freddie will be creeping nationalised, what is at stake is the very confidence of the financial system in US mortgage backed securities, and therefore the ability of the US home lending system to function.

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