Nationalizing Fannie and Freddie: Latest Move in the Housing Crisis

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Includes: FMCC, FNMA
by: Brad DeLong

Henry Paulson did it: He nationalized the GSEs Fannie Mae and Freddie Mac.

OK. Here is what is going on:

* Fannie Mae and Freddie Mac give the Treasury each 80% of their (common) stock and $1B (each).

* The Treasury promises to keep Fannie and Freddie solvent according to GAAP by lending it money at 10% per year.

* The Treasury promises to keep Fannie and Freddie liquid by buying its MBSs, financing the purchase by selling more Treasury bonds, and then holding the GSE MBSs to maturity.

* The Treasury, the Fed, and the FHFA will agree on an additional amount -- a "commitment fee" -- that Fannie Mae and Freddie Mac must pay to the Treasury starting in March of 2010.

This deal seems to me to be motivated by five things:

* Paulson's desire to make sure that there is no way in hell that either Fannie or Freddie can ever be adjudged insolvent according to GAAP -- which would trigger all kinds of bond-market unpleasantness.

* Paulson's desire to make sure that there is no way in hell that either Fannie or Freddie will wind up illiquid--out of cash.

* Paulson's desire to make sure that there is no way in hell that Fannie Mae's and Freddie Mac's stockholders profit substantially out of this.

* Paulson's desire to make sure that there is no way in hell that the CBO can calculate that this deal is likely to cost the government money -- if CBO threatens to so conclude, he can always up the commitment fee.

* Paulson's desire to keep the options open for his successor to shape the long-term debate about how to restructure these GSEs.

Terms of the Agreements:

* The agreements are contracts between the Department of the Treasury and each GSE. They are indefinite in duration and have a capacity of $100 billion each...

* If the Federal Housing Finance Agency determines that a GSE’s liabilities have exceeded its assets under generally accepted accounting principles, Treasury will contribute cash capital to the GSE in an amount equal to the difference between liabilities and assets. An amount equal to each such contribution will be added to the senior preferred stock held by Treasury ... senior to all other preferred stock, common stock or other capital stock to be issued by the GSE...

* In exchange for entering into these agreements with the GSEs, Treasury will immediately receive

  • $1 billion of senior preferred stock in each GSE
  • Warrants for the purchase of common stock of each GSE representing 79.9% of the common stock of each GSE on a fully-diluted basis at a nominal price

* The senior preferred stock shall accrue dividends at 10% per year. The rate shall increase to 12% if, in any quarter, the dividends are not paid in cash, until all accrued dividends have been paid in cash....

* Beginning March 31, 2010, the GSEs shall pay the Treasury on a quarterly basis a periodic commitment fee that will compensate the Treasury for the explicit support provided by the agreement. The Secretary of the Treasury and the Conservator shall determine the periodic commitment fee in consultation with the Chairman of the Federal Reserve. This fee may be paid in cash or may be added to the senior preferred stock...