GSEs: my own private RTC
Now that the
Fannie, Freddie to Step Up Mortgage Bond Purchases
What? I thought. This is what got them into trouble!
Neither Fannie nor Freddie has turned a profit in the past year, accumulating $14.9 billion in combined quarterly losses, largely related to bad subprime and Alt-A mortgage assets.
Didn’t going this way land us in deep doo-doo to begin with?
Oct. 13 (Bloomberg) –
The date is significant – it’s literally the day before Treasury announced its equally remarkable shift in TARP strategy, investing capital into banks instead of buying their asset pools. That’s what we mystery writers call a ‘clue.’
Whodunnit?
Fannie Mae and Freddie Mac are ready to start purchasing $40 billion a month of underperforming mortgages and bonds as the
Unlike the banks sale to Treasury of huge preferred-stock positions (posted Monday and Tuesday), which are voluntary (at least, that’s the duly publicized, and legally binding, cover story), this move – back into the frying pan, as it were! – is coming at Treasury’s explicit direction:
Fannie and Freddie began notifying bond traders last week that each company needs to buy $20 billion a month in mostly subprime, Alt-A and so-called scratch-and-dent mortgage securities that contain a higher portion of underperforming loans, according to the people, who asked not to be identified because the plans are confidential.
Needs to buy means “was told to buy.”
The Federal Housing Finance Agency, which placed the two companies in conservatorship on Sept. 7, directed them last month to start increasing their purchases of loans and mortgage-backed securities as the Treasury seeks to absorb underperforming and illiquid assets from financial companies.
Why?
Because I said so!
The purchases would be separate from the U.S. Treasury’s $700 billion Troubled Asset Relief Program.
Again my jaw hit the floor.
What now?
Treasury had just secured enormous, unprecedented, sweeping legislative authority to acquire assets directly. It had used that authority not to buy TARP assets but instead to pump capital into banks.
You need capital? Here, have some
Now it was directing its new captives – Fannie and Freddie – to buy TARP assets, in a manner that doesn’t count against the TARP ceiling?
In Charlie and the Chocolate Factory, each evil child who received a golden ticket dies horribly in a gluttonous overdose of his or her previous craving. (You can imagine what might happen to Augustus Gloop.) Now the GSEs, whose recent overindulgence landed them in conservatorship, are forced to eat up everyone else’s leavings, at the rate of forty bil a month.
“I’ve got the Golden Ticket!”
Shifting from Treasury buying TARP assets to the GSEs’ buying them doesn’t change some core elements:
“Just because Fannie and Freddie are doing it instead of the TARP authorized by Congress doesn’t change the fundamental problems of how you price this stuff,’ said William Poole, a senior economic adviser at Merk Investments LLC and former president of the Federal Reserve Bank of St. Louis. “If they overpay, it’s going deepen the losses that Fannie and Freddie report and will produce windfall gains for the banks that sell to Fannie and Freddie.’
Previously I’ve approvingly cited Mr. Poole’s works on the risks that GSE flesh is heir to (March, 2005), and GSE reform (June, 2007), so my disagreement with him is one of emphasis rather than assessment. Sure, the GSEs could overpay, but – as I wrote at length in Bailout or Bonanza? – there’s no intrinsic reason to think they will. Or if they did, they already have:
Just one wafer-thin CDO, sair
Adding underperforming assets to Fannie and Freddie’s combined $1.52 trillion mortgage portfolios would come at a time when the two mortgage-finance companies already hold as much as $210 billion of bad debt that may be eligible itself for the Treasury’s relief program, their regulator said Oct. 5.
Non-agency, or private-label, bonds are issued by banks and don’t carry guarantees by Fannie, Freddie or government-agency Ginnie Mae. Freddie held about $207 billion in non-agency debt in its $760.9 billion portfolio as of August, according to its latest monthly volume summary. Fannie had about $104 billion of such securities in its $759.9 billion portfolio in August.
Over at Recap, I’ve posted two long essays on TARP, one entitled Paulson’s Patent Medicine: Lessons from the RTC., which included this passage:
Everybody will have taken lessons from the RTC.
We could all use some nerve and brain pills about now
Here are the ones I derived:
Buy cheap. Though the headlines have screamed BAILOUT, Treasury is likely to drive a hard bargain. Entities will sell only because they have to clear good-but-complex assets from the balance, and in so doing not only recover that cash but free up cash elsewhere. Those who part with goods will hate themselves for having to do so.
Start fast and keep moving. What I remember best of all was that: the RTC was up and running in a very short time, and it threw procedures, proposals, and property portfolios into the marketplace with great boldness.
When I wrote those words, I thought Treasury itself would be doing the restructuring … and scarce days later, Treasury declined that role, preferring instead to inject capital into quiescent banks and leave them with their own assets. But somebody has to be the subprime RTC, and if it wasn’t going to be Treasury, who could it be?
Who gets the Golden Ticket?
The GSEs are probably better positioned to do it than anybody else. Who needs a new Resolution Trust Corporation when the government already controls two entities that already bought a lot of these assets, and that are in the business of making loans – and hence, need to be in the business of fixing them?
Using the GSEs as the new RTC clearinghouse makes Willy-Wonkan sense, doesn’t it?
Yes, yes, we win the prize!
It’s also consistent with the do-as-little-as-possible mantra within Paulson’s Principles. Treasury is using its money power to place work responsibility elsewhere, outside of government, in the hands of private-sector entities that will lose or make large sums based on how well they untangle what they have previously tangled.
Fannie and Freddie which own or guarantee almost half of the $12 trillion U.S. home loan market, were given access to $200 billion in emergency Treasury financing as part of their rescue package. The companies may also be able to sell their bad debt to the Treasury through its $700 billion financial-rescue program signed into law Oct. 3.
Maybe – once they’ve cleaned it up.
Once more into the breach, dear friends, once more! shouts King Harry to rally his troops besieging Harfleur. It sounds heroic until you hear the followup line:
Or else close up the wall with our English dead.
Some of us have to take one for the good of the country
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