Is the Government's Fannie/Freddie Conservatorship Failing?

The Wall Street Journal's “Mortgage Plan Isn't Cutting Rates” summarizes the track record of Fannie Mae (FNM) and Freddie Mac (FRE) since the 79.9% solution (conservatorship):

• The conforming 30-year fixed rate mortgage rate rose from 6.34% to 6.64%.
• GSE five year notes are selling for 1.5% over equivalent treasuries.
• GSEs are increasingly funding mortgages with short-term paper.
• Running a mismatched book requires the GSEs to increasingly depend on derivatives.
• Writing off tax credits will wipe out a substantial portion of the GSE’s capital.
• Decision making is slow because the regulator’s approval is required for anything of importance.
• Total investor confusion about the government’s guarantee of the GSE debt.

On the positive side, Fannie CEO Herbert Allison and Freddie CEO David Moffett both stated during last week’s mortgage banker’s conference that the GSEs must be fairly compensated for risk. This tells me that despite Treasury Secretary Paulson’s rhetoric about running the GSEs for the public benefit, Paulson wants the GSEs to be run as profitable and sound businesses.

The good news for GSE shareholders is that Paulson is minding his portfolio. We have a pattern developing of Paulson asking Congress for government money so that financial institutions can benefit consumers, then using the money to strengthen his portfolio. Paulson chooses only the financial institutions he sees providing a good return and acting as an activist investor to insure that it happens. The winners and losers have already been chosen, with the losers fed to the winners. Given this track record, the heavily diluted GSE shareholders might not be total losers after all.

Paulson is, however, failing in the delicate tightrope walk of the GSE debt government guarantee. The government does not actually guarantee any GSE debt, but will provide capital to the GSEs to prevent their negative net worth. Even Federal Housing Finance Agency (GSE regulator) Director James Lockhart was confused during Congressional testimony as to whether the government was granting an "explicit" or "effective" guarantee. Investors are not buying that GSE debt is equivalent to treasuries.

My understanding is that the GSEs will continue to file SEC quarterly reports. I can’t wait for the conference calls.

Disclosures: Author is long FNM and FRE.

Comments

[Poor me:]

(Decision making is slow because the regulator’s approval is required for anything of importance.) They don't seem to make slow decisions when it come to something they want. Like the Bail out. They pushed it through as fast as they could, before anyone had time to look it over.

2008 Oct 31 11:15 AM

[Smarty_Pants:]

"Is the Government's Fannie/Freddie Conservatorship Failing?"

Was there ever any doubt that it would? It's the gub'mint after all. The only thing they do well is lie, steal, and fail.

2008 Oct 31 11:37 AM

[buyitcheap:]

This was never about rates. It was about the evaporation of capital bases.

Rates must go up as more debt is issued and more dollars create inflation. Shorting the long end of the yield curve is the easiest money out there right now (while its still legal anyway.)

2008 Oct 31 11:54 AM

[Apple at 60$:]

you are just purely stupid

2008 Oct 31 02:15 PM

[User 289499:]

"Given this track record, the heavily diluted GSE shareholders might not be total losers after all." No one has been diluted (yet). The Gov't does not "own" one share of either firm. They also have not put in any capital yet that they have disclosed. FRE/FNM are still raising their own capital. Right now the Gov't has only provided guarantees and has an agreement in place they could exercise if they wanted.

American public will NEVER let them take on a perceived $5 Trillion debt.

FRE/FNM will be a HUGE profit machine for everyone invested right now!

2008 Oct 31 03:14 PM

[richard_nog...:]

I hope you are right about FNM becoming a profit machine again. Every month I'm adding 90-100 shares.

I'm afraid that Freddie will have to get government support next month, when they are forced to sell assets like Fannie was this month.

2008 Oct 31 03:43 PM

[ClairePaula:]

hello, I'm a Duch investor in Freddie. I would like to know how you think about Freddie's future on the short term. The stock is now 1,03 dollar. Will it rise or go down for the next few weeks? Thanks for your reaction. I think Freddie wil rise, because the financial market is stabalising....... Ik hope.......

2008 Nov 01 08:38 AM

[madasiwannabe:]

ClairePaula, there's a lot of questions still left unanswered and too many contradicting comments from Paulson and Lockhart, so until their's a solid direction and consistancy in communications with those involved, the GSE's will continue to move up and down.

FIrst they say they have enough capital to continue to operate for 6 quarters, then they take them over and wipe out 36 Billion dollars worth of shareholder value. Then they bash them for becoming too big, and turn around and order them to become bigger... They say they are in financial trouble and tell the world their job is to protect their assets and return them to profitibility as possible, then they say they are going to use them to buy up troubled assets from the finanacials, which would destroy what's left of shareholder value. If they are in trouble why hasn't the treasury used any of the "Backstop" money?

They are suppose to release Q3's on the 17th, but once again, Lockhart commented several weeks ago they didn't have to report while in conservatorship. I think investors are scared to put any money into either Fannie or Freddie because of the obvious "new management" issues. Until these guys go away, I wouldn't go anywhere near either Fannie or Freddie.

2008 Nov 01 01:59 PM

[Scooter_in_fl:]

You need to look at this from the outside. I know it is hard but consider the forces at work. Some things are undeniable. First the government is not going to take on an extra 5 trillion in debt on the books. So permanent nationalization is not going to happen. Next, they are too big to fail is not something the American people are ever going to want to hear again after this problem is resolved. So they will be made smaller once they are recapitalized. Will it be 12 new companies make by breaking them up? I do not know. But I do know they hold 5 trillion in debt that can be sold off and that is more than enough to make every share holder very happy. I know most people do not see this yet and are scared but this is really a no brainer. when it happens the stock price will jump so fast that if your not already in it you will not be able to get in. Big money is just waiting for the inside information to tell them it is safe. I for one feel there is nothing to risk at this price point. I have already told all of my friends abouot this and told them not to be bitter when I am rich if they did not follow me...

2008 Nov 01 10:26 PM

[attila:]

Well, the fact is, that an elementary school education is satisfactory to
run the GSEs. Most of the decisions are based on repetetive actions.
The previous CEOs should had been jailed for mismanaging the company
to lead to the wipe out of the shareholders. If they would had acted
promptly instead of blaming the system you could not wrote this very
unprofessional article. Are you trying to blame now the government for
the years of corrupt management done by idiots ?

2008 Nov 03 04:10 PM