Greenspan & PIMCO: A Gross Conflict of Interest

Former Federal Reserve chairman Alan Greenspan was on CNBC last week, ranting about Fannie Mae (FNM) and Freddie Mac (FRE):

I think the solution here ultimately is going to be ultimately, a nationalization of both Fannie and Freddie. And I hope a restructuring in nationalization more capital coming from taxpayer money. And then split them up into five or ten separate entities and sell them back in the market.

Appearing with Greenspan on the “Closing Bell” show was PIMCO’s Managing Director and portfolio manager Paul McCulley. PIMCO, the world’s largest bond fund manager, hired Greenspan in May 2007 as a consultant. Yet at no time during the interview did Maria Bartiromo ask Greenspan and McCulley to disclose this relationship and how nationalizing the GSEs would result in a windfall profit for PIMCO.

If the GSEs are nationalized, the spread between Treasuries and the Fannie and Freddie debt will be compressed. The GSEs interest rate costs will go down as their debt would be seen as almost equal to Treasuries. Bond values are inversely correlated to interest rates. Treasury interest rates would rise and their values would decline due to the added equivalent supply. Correspondingly, the outstanding GSE debt will show sharp capital gains, so PIMCO will see a large benefit as they are a big holder of GSE debt. Besides PIMCO, banks would also benefit from GSE nationalization. Banks are also large holders of GSE debt as the debt can partially count toward a bank’s capital requirements. Banks are holding over 50% of the GSEs $5 trillion debt.

Greenspan, PIMCO and the banks should be careful what they wish for. GSE nationalization would cause investors to be wary of purchasing equity in any US financial institution. This would raise the cost of new capital to all financial institutions, regardless of their condition. Banks would have to reduce their balance sheets and contract lending. The fallout would be higher interest rates for both businesses and consumers.

Basically, Greenspan/PIMCO would like the government to do a hostile takeover LBO of Fannie and Freddie so PIMCO could benefit at the expense of shareholders and US taxpayers. Then the investment banks would immediately get to work on creating IPOs for Greenspan’s “five or ten separate entities.” The IPOs will fail to attract subscribers because if the government takes over a financial institution once, who’s to say they wouldn’t do it again? GSE nationalization is a one-time “total return” for Bill Gross and PIMCO.

Disclosure: Author holds a long position in FRE

 

Comments

[texalope:]

Interesting perspective. I never thought about buying GSE debt as a short bet of FNM and FRE. This make a company like NLY an interesting investment with little down side risk.
What is your rationale for owning FRE common at this point?

2008 Aug 10 06:18 AM

[investor88:]

This article discusses the possibility of nationalizing Freddie and Fannie. There just isn't a simple obvious solution out there which means the path ahead continues to be very difficult. Only time can ease the economic pain whatever solution is choosen.

2008 Aug 10 06:38 AM

[madasiwannabe:]

I knew the backstop would bring these kind of money grubbing cockroaches out of the woodwork. Notice that PIMCO is also a sponsor of some of the programming on CNBC too. CNBC's ruthless GSE bashing campaign was completely lopsided reporting. FBR's Paul Miller blatently pumped Freddies stock the day before Freddies Q2 report to make the bad news even more dramatic.

This is beyond conflict of interest and beyond SEC violations. The FBI should be persuing RICO charges against both of these companies!!!! I will never watch CNBC loser network again!!!

2008 Aug 10 08:35 AM

[Jason Rines...:]

Your correct Madasi, unfortunately all things tie back to Washington and the leadership is corrupt to make the changes needed in the short-term. The fox runs the hen-hound in other words so most investigations and conclusions will be skewed in favor toward those in power. The fox must go for this to change. And I am not referring to Obama change either.

2008 Aug 10 11:32 AM

[strongopinion:]

I am in complete agreement and if the attorney general was doing his job he would bring charges against Alan Greenspan for allowing him to use his influence to effect the market price of Freddy and Fannie to the negative for his and Pimco's gain. This is not the first time he has done this. Regarding Maria Bartiromo's interview she is much too smart in my estimation, to have allowed him to get away without stating that he worked for Pimco and Pimco had major positions whereas they stood to gain many millions of dollars if the stockholoders were wiped out by the government takeover or the stocks suffered a major setback in value.

2008 Aug 10 12:23 PM

[helplessobs...:]

All this makes the mistaken assumption that the sharre holders in the GSE's will take this lying down. Massive losses have occurred in mutual fund holdings etc. They will be heard from in time.

2008 Aug 10 01:00 PM

[prescient11:]

Greenspan contributed in a big way to the current mess, why should anyone listen to this blowhard.

2008 Aug 10 02:19 PM