Fannie's Tax Credit Sale to Goldman: No Deal

This is an odd ending to this saga. Some very big names were involved. Fannie Mae (FNM) clearly wanted to do a deal; the regulator for Fannie (FHFA) was strongly supporting it. Goldman Sachs (GS) was looking to make a buck putting the transaction together and selling it to Warren Buffett (BRK.A). So why didn’t it happen?

Based on the information provided in Fannie's 10-Q the terms and conditions for the transaction were agreed to and a nonbinding contract was entered into prior to September 30th. The condition for a go ahead was subject to Treasury’s approval. Saturday we learned that Treasury has said no.

Treasury’s basis for nixing the transaction was pretty clear. In their view it would have resulted in a net loss to the taxpayer, . From the WSJ:

Treasury Department officials blocked the deal after concluding that it would have resulted in a loss of tax revenues greater than the savings to the federal government had it allowed the sale. "In short, withholding approval of the proposed sale affords more protection of the taxpayers than does providing approval".

That conclusion is at odds with Goldman Sachs. Mr. Michael DuVally a GS spokesman said of the deal:

The only basis on which approval for any transaction would be given would be if it was clearly in the taxpayers' best interest.

So who is right, GS or Treasury? Just this one time I am going with Goldman. They would not have made the statement to Bloomberg unless they had the numbers to back it up.

This was not a simple matter of Buffett writing a check and getting a specified tax benefit. It involved an asset transfer, presumably funding would have been required. The tax benefits would have been realized over a period of time. At some point in the future the assets would have reverted back to Fannie. This was a rental of tax benefits.

Given the complexity, it is possible that the parties had different measuring matrix's when assessing the merits of the deal. But I doubt that. Clearly Fannie’s management and regulator were happy with the numbers. They must have considered the taxpayer side of this before signing the deal. Same for Goldman and Buffett. They understand the necessity of passing the “Smell Test” these days.

My guess is that this deal did not crater because of bad economics. It bombed because of bad optics. The Administration did not want to be seen as facilitating a transaction that would have been perceived as benefiting the ‘Fat Cats’.

This is a sign that D.C. is well aware of the fact that a significant percentage of the populations hates our public and private financial institutions. They understand that this issue is the “Mother of all Systemic Risks”. In that light, the Administration’s decision to nix the deal makes a great deal of sense.

I fear that net net; the taxpayer will pay a price for this choice. I, for one, would like to see the actual economics of the transaction. Possibly Treasury could provide the details. My guess is that over the next five years this will cost us a few billion. That would be a cheap price if it placated an angry population. I doubt it will.

NOTE:
There is nothing new in the proposed transaction. Fannie did this in 1999 with Citicorp (C):

WASHINGTON, March 16 /PRNewswire-FirstCall/ -- Citibank, N.A. and Fannie Mae today announced that Citibank purchased from Fannie Mae a portfolio of investments representing approximately $676 million in federal Low Income Housing Tax Credits (LIHTC) for cash plus the assumption of Fannie Mae's capital obligations relating to the investments.

In it’s November 5, 2009 10-Q Fannie Mae discusses the proposal. The cost to them of not disposing of the tax assets? $5.2 billion.

As of September 30, 2009, the carrying value of our LIHTC investments was $5.2 billion.

Comments

[Alfredo Mar...:]

Don't you love all of Warren Buffet's grandstanding about how the government should raise taxes, and here's Warren trying to cut a shady deal in order to lower Berkshire's taxes.

Do as I say, not as I do.

Nov 08 02:27 AM

[xyzlmnop:]

What part of the deal is "shady"?
It's entirely within the law, and ultimately, as we saw, subject to Government approval. How much more open could it be?

Nov 08 07:45 AM

[John McLeod:]

Fannie (under a nightmare "conservatorship" until it inevitably blinks out sometime down the road) is in effect back to its pre-1968 persona as a government department. It can no more legally sell its tax credits than we could have sold our DND-earned Air Miles on eBay. This is all about laundering public funds in such a way that Agency Debt can stay junior to treasuries. They're defending the ambiguity of the "effective guarantee." A side effect would have been Goldman and Buffett siphoning off something like a billion dollars risk free for their intermediation services. Thus the thief-in-the-night timing. It nearly worked this time, and next time it will.

Nov 08 08:49 AM

[loftman:]

treasury made the right move. i am a tax credit developer & for the past 18 months wall st & all the big boys (fannie, freddie, BOA, Wachovia, etc) have walked away from the market, driving down pricing 40%. this has had the effect of increasing the investor yield from 6 - 12+%. it has taken a while, but there are some new players @ the table now (attracted by the bigger return) & there are still lots of new product in need of tax credit equity. The effect of a big goldman/buffet buy would be eliminating their tax liability on old credit deals the govt is in effect holding, driving down appetite (& price) even further, resulting in more govt bailout in the short term.

treasury is saying in effect - go buy the new deals, we will sit on these credits until the mkt stabilizes (around a 9-10% irr i think), then we will release when the demand is back (ie companies making $ again)

a quick sale @ probably a 20% irr would have done nothing but fatten warren & goldman, while costing the taxpayers more to prop up the market even longer.

saying no was a no brainer & im glad to see treasury get this one right.

Nov 08 09:51 AM

[Brad Johnson:]

If it wasn't shady, why did the Treasury Dept. say no? Maybe they even have the ability to be embarrassed?


On Nov 08 07:45 AM xyzlmnop wrote:

> What part of the deal is "shady"?
> It's entirely within the law, and ultimately, as we saw, subject
> to Government approval. How much more open could it be?

Nov 08 11:00 AM

[BRUCE E. W.:]

So who is right, GS or Treasury? Just this one time I am going with Goldman. They would not have made the statement to Bloomberg unless they had the numbers to back it up

This is a bit hair raising as an excuse for due dilligence of any flavor, but otherwise a good focus on a complex and subtle issue that would have otherwise gone unnoticed. Some excellent commentators also added to the information flow with convincing arguments that clearly showed the duplicity in the shades.

Nov 08 04:09 PM

[countrybanker:]

Shady because not a public bidding contract. Who all had chance to bid? The govt often bids out $100,000 mnfg contracts, but Fnma was going to do this deal without PUBLIC bidding. Get out of your cave.

Buffett and GS have forgotten more than any Fnma officials have ever learned. GS dealing with gov't officials...is like taking candy from a baby. GS and Buffett get the candy and the populist taxpayer just cries like the baby!!!

Interesting thought is whether the baby will ever get the candy back? I think GS has warn out its welcome in America.


On Nov 08 07:45 AM xyzlmnop wrote:

> What part of the deal is "shady"?
> It's entirely within the law, and ultimately, as we saw, subject
> to Government approval. How much more open could it be?

Nov 08 06:57 PM

[countrybanker:]

So who is right, GS or Treasury? You think GS?

Fannie and Treasury are owned by US taxpayer. Unfortunately, Fnma executives are thinking of Fnma instead of their 100% owners, the taxpayer.

When taxpayer moves money from the front right pocket to the front left pocket, there is absolutely no reason to do and nothing gained! Nor should there be anything lost!!

But , appropriately, GS and Buffett have profit motives. They are both smart enough not to do this without great returns..So, why pay the returns? Cancel the damn tax credits. Or, have Treasury buy then for 100 cents on the dollar. Fnma gets more and to the taxpayer its a non event.No losses and no transaction arbitrage fees to GS.

Nov 08 07:08 PM

[lazzybum:]

Bruce think we are idiots with this blog. Based on the comments, there is only one idiot among us.

Nov 09 09:06 AM