Rescuing Frannie

Includes: FMCC, FNMA
by: Felix Salmon


It's easy to get caught up in the minutiae -- should shareholders be wiped out, or merely massively diluted? What should happen to preferred shareholders? Can the government create a new class of senior subordinate debt, and if so, should it? But for me everything finally clicked into place just when I saw the headline above on Bloomberg.

Of course Frannie should be under government control; of course the CEOs should depart. The government is bearing all the risk; the CEOs have done nothing but destroy billions of dollars in value over the past year, and have proven themselves incapable of raising vital new equity capital.

This is all happening, Bear Stearns style, over the course of a weekend -- a fact which makes it seem as though there's some kind of emergency here. There isn't. If Fannie and Freddie aren't taken into conservatorship on Sunday, they'll still be able to operate on Monday just like they did on Friday. They have enough liquidity to keep on going more or less indefinitely, unless and until the government finally decides to intervene.

But they've failed as private companies, and Paulson's attempt to bring their spreads down by making the government guarantee explicit didn't work. Let's just do this thing, people, and get the companies run by technocrats in the public service rather than CEOs beholden to a small group of shareholders. The shareholders shouldn't be calling the shots right now: their equity is worthless, certainly when placed next to Frannie's mountains of debt.

The spreads still won't come down to zero, but they will come down. And I'd welcome a full delisting: if FNM and FRE still trade on the stock market, analysts and reporters will continue to unhelpfully obsess over the share price to the exclusion of much more important bond classes.

It would be nice, too, if the preferred shareholders were forced to take a substantial haircut. Yes, I know that they're largely regional US banks, and I know that the last thing regional US banks need right now is extra losses imposed by the US Treasury. But if those banks are going to get a Treasury bailout, it should be done explicitly, and not implicitly via a failure to let equity holders (and preferred shares are equity) take any losses. Otherwise, it's not fair to those regional banks who were smart enough not to invest in Frannie.

In times like these, bailouts are often, sadly, necessary. And if you are going to do one, it's always better to do it sooner rather than later. Let's inject some government money into Frannie now, and maybe a bit more into the regional banking system, if that's necessary as well. The shareholders will take their lumps, and the credit crisis will continue: this is no panacea. But at least the last vestige of a possibility of a trillion-dollar agency debt implosion will have been taken off the table.