Unintended Consequences of the Fannie / Freddie Bailout

As of now, the Fannie (FNM) and Freddie (FRE) story is pretty well known, and has been looked at from a number of different angles (see various articles and posts here, here, here, and here). Now we find out that the auto industry is set to press Congress for $50 billion in low-interest auto loans (see CNN Money article). The government loans are expected to be used to help modernize plants and help the car companies make more fuel efficient vehicles. Congress had already authorized $25 billion in loans last year, but apparently that is now not enough. It is believed that the loans would have rates between 4-5 percent. Even though market rates are fairly low already, the credit ratings of both Ford (F) and GM (GM) have fallen below investment grade, making it difficult to borrow anywhere near 5 percent.

This of course makes one wonder at which point all of this stops. Sure, it is important to keep Fannie and Freddie and the general housing mess from bringing down the financial markets, but at what cost? Starbucks (SBUX) has fallen on hard times. Should they get some type of bailout or support? What about Sears Holdings, with the struggling Sears (SHLD) and K-Mart retailers? Is it time for the airlines to go back to the well? The argument of course is usually attached to the financial sector, talking about things like contagion, or national interest, for industries such as defense and manufacturing. But where is the consistency? Just as loans are being requested to help build hybrids, electric cars, and other alternatives, other measures to increase low cost electricity or reduce our energy independence are met with resistance. Even more unsettling is that by choosing to bail out Fannie and Freddie, we (the taxpayers) are now all investors in the mortgage markets, whether we choose so or not. To add insult to injury, we can even lose more than our initial investment.

Of course the real issue of concern may not be whether or not a specific industry or company is receiving low interest loans or a nice government contract, or whether we are being forced to invest in risky companies against our will, but whether the trend of privatizing profits and socializing risk is really good for free markets. As readers know, I often discuss the need for risk management, but unfortunately for many companies their idea of risk management is simply letting the government take the reins when things go bad. Again, the point is not specifically about the current problems or plan proposed by Secretary Paulson. It appears that he had no other choice, and as he stated on CNBC, "played the hand he was dealt." Yet, should it have gotten to this point?

As is now obvious, banks kept making loans without worry of whether homeowners would pay them back. They could simply sell the loans off to Fannie and Freddie, sponsored in part by the government. While Fannie and Freddie were indeed "just" sponsored entities, there was always a "wink-wink" understanding that the government would step up in times of need. As such, both risk and return were adjusted accordingly. Yet, this was part of the problem. By having in place what amounted to a zero deductible insurance policy, Fannie and Freddie could go off and look for ways to juice returns by creating portfolios that really had no purpose other than to help meet quarterly numbers and make Wall Street and shareholders happy - all the while knowing that if things got bad, Uncle Sam was there to save the day. Well, that day has come, and now the government is left with few options, taxpayers are left with more risks and unwanted investments, and the free-markets are a little less free. Where does it stop?

Comments

[Andy Singh:]

All I can say is just be careful about investing into this temporary bubble. As I posted recently, the impacts and outcomes of this bailout have a long way to go still.

2008 Sep 08 02:46 PM

[mcadoo3312:]

Invest into what temporary bubble? Last I checked, nothing had been doing well.

2008 Sep 08 03:16 PM

[gabe borens...:]

The FRE and the FNM now implictly have gained AAA/AAA rating -that of the U.S Treasuries (Not the common nor preferred shares) ..Each agency has gained up to 100 billion dollars of potential capital infusion and a lot of time to turn profit.This decision is just as valid as the British Government's decision to nationalize "mortgage bank" in order to avoid market chaos.
By "nationalizing"the agencies market and financial sector destructive rumors have been neutralized..
The agencies will provide more liquidity into the housing sector ,stabilizing that segment of the market.The rebounding economy will take care of the rest in the period ahead.
The investment of the common and preferred share holders was diluted but not eliminated .True, the share holders are last in line to claim assets in case of chapter 11,but in this case ,take over eliminates the probability of the agencies going under.More importantly the share holders always last in line (creditors/investors).
Given the price implosion of the shares in both agencies (to date),it is clear that the market had discounted the Armageden.
In fact the share holders had accepted dilution for agencies duration ,stability and ability to "operate"as intended.
Today's knee jerk reaction to the Treasury announcement had further decimated the price of shares of both agencies.
FRE and FNM are important and economically relevant institutions.
Investors (stock ) have respondent favorably to the agencies needs
by investing in stock recommended by the "experts".
Now the "mega shorts(hedge funds") as well as some politicians are calling these investors speculators -not so.
In the meantime the agencies are here to stay and the share holders
have plenty of time to be rewarded-and they will be.
What happened to the voices of doom when I have issued the warnings as late as last year?
At 70 dollars the agencies were a buy ,at 75 cents they are the sell.I am sure that a great deal of the analytical input went into this conclusion.

2008 Sep 08 03:31 PM

[ceekay:]

"and the free markets are a little less free" - I was following this argument till that statement - what planet is the writer on? and of what strange logic does he make his statements?

2008 Sep 08 04:02 PM

[fatcat:]

ceekay,what didn't you understand about that statement...if you were a fannie/freddie common holder,you would understand.

2008 Sep 08 04:09 PM

[DaveW:]

CK,
"free" = allow the market to price-in realistic risk by allowing any institution the chance to fail.

"not free" = misled with false infationary data, false GDP data, etc.; safety netted with a 'too big, too important to fail' bail out.

get it now?

2008 Sep 08 04:41 PM

[MarvinMBA:]

Everybody is going to be a loser with this overall financial and energy crisis. THERE IS NO SUCH THING AS A FREE LUNCH sombody pays....the market is acting as if the bailout is free and they are ready to play their next game. This just means that our national coffers are now poorer and owe more...but inflation could bale us all out...if Uncle Sam could just get a good grip on how to inflate the housing market and start the game all over again. IF TIGHTER LENDING STANDARDS is something they really mean WHERE ARE THE JOBS GOING TO COME FROM TO PAY ALL THE BILLS. Look out below because we still have a long way down to go before somebody comes up with a realistic productive paradyne for this country. Meanwhile look for MORE INFLATION AND HIGHER INTEREST RATES going forward.

2008 Sep 08 05:06 PM

[DHJ:]

"and the free markets are a little less free"

Its simple really.

By definition government intervention in markets = not free markets.

2008 Sep 08 05:08 PM

[whidbey:]

This is a bad habit of government. It leads to moral hazard, or damned foolishness as we say in our office. In any case we know the auto companies are in terrible shape, and what they know and could care less about is that the government's Treasury is in the same or worse shape. Which raises the question of the government's backers. Will, how are you doing suckers??

2008 Sep 08 05:14 PM

[jwmr:]

When will we start investigating former Goldman Sachs employees and all their cronies starting with Mr Paulson? Aren't these the same people that created this mess, grew very wealthy and eventually brought down the system. Are they returning any of their ill-gotten wealth? They have made a very simple system into a complex model that does not work and even they themselves do not understand. It would be very nice if we could create from thin air a piece of paper or better yet from a computer entry a hedge to lay off all the risk. What we have found in the real world is that it only works until you try to place a value on a worthless piece of paper! Keep printing it's what you do best!

2008 Sep 08 06:27 PM

[Sideliner:]

The government have again and again to intervene the path of the market, first Bear Stearns, now FRE and FNM. This is just to prolong the trouble market, and with what cost? (the taxpayer money). Mr. Paulson have use his bazooka trump card, but how many rocket shell can he fire when taxpayer themselves are also in trouble.

2008 Sep 08 06:28 PM

[freejack:]

What are your thoguths on LM?

Why is Bill Miller Increasing His Stake in Freddie Mac?
seekingalpha.com/artic...

Fannie, Freddie: The biggest losers
money.cnn.com/2008/09/.../

Bill Miller bets on Freddie Mac
dailybriefing.blogs.fo.../

Mean Street: Losing Faith in Freddie Mac and Bill Miller
blogs.wsj.com/deals/20.../

A humbling period for Bill Miller of Legg Mason
www.iht.com/articles/2...

Legg Mason's Miller still a 'long-term optimist' despite market turmoil
www.bizjournals.com/ba...

Mass. Pension Loses Trust In Legg Mason
www.forbes.com/2008/08...

Bill Miller bets on Freddie Mac
www.silobreaker.com/Do...

Who’s Afraid of Fannie and Freddie?
dealbook.blogs.nytimes.../

2008 Sep 08 06:42 PM

[otbricki:]

Let's be real here - the US public policy has been to subsidize home ownership for many many years - interest deductions, federally supported loans, etc. This has led to overblown home prices, use of real estate taxes by local government as the primary revenue source, use of real estate appreciation as a substitute for personal savings, you name it.

The only way these distortions will go away is to get rid of this marketplace distortion completely - no housing subsidy.

2008 Sep 08 07:51 PM

[willyt:]

When the DOW hits 12000, bail into inflation-linked securities. I warned you!

2008 Sep 08 09:31 PM

[liamffid:]

bailing out the greedy conniving blood sucking bonus loving wall street types is the last thing we need. when dot com happened, wall street bonuses hit an all time high. when the mortgage crisis happened, it was deja vu all over again. Is that a coincidence or what? You buy a house, you get screwed. You save for a down payment, FED and hanky panky screw you over. This is very disappointing. OWNED is what this is.

2008 Sep 09 02:22 AM

[bobtailnag:]

Jim Rogers get's it. When in one day a government takes over control of 50% of the people's homes ( "We veel make them pay and pay on time - Vee promised the Chinese) it is necessary to next take control of the Insurance portfolios guaranteeing the lives and property (We veel make you pay ze premiums and it ees gut that some die early to help zee faderland) and of course there is the public school system, gas and oil and auto industry (Vee must have safe, cheap transportation like zee Volksbug).

2008 Sep 09 06:31 AM

[Online Trading:]

A very good question David.. where will it end? I happen to think, as most people I am sure do, that the alternative to bailing out F&F would have been a catastrophe, but now auto-manufacturer loans. At some point the 'free market' has to be... er.. 'free'.

2008 Sep 09 07:40 AM

[WEBISKING:]

Look when you have to solve your childs problem inthe preseent you do NO good in mentioning his sins of the past. This had to get done.Th majority of Americans wealth is in their stocks and this housing probem needs to "try" and go forward

2008 Sep 09 09:06 AM

[SW Richmond:]

webisking,

I don't wanna be kept like a goddamned pet. Solving my kids problems would have involved making them more free, not saddling them with taxes to pay off Chicom investors. Time for us to get passports, Switzerland is looking damned good.

2008 Sep 09 09:39 AM

[potenz:]

This is not brain surgery. The late great President Reagan deregulated the banking industry. This is what happens when all stops are removed as evidenced by the price of housing, ect.. President Clinton promised to balance the budget and start paying down the debt, which happened. President Bush was elected and all that was accomplished was destroyed.
P.S. President Reagan promised to balance the budgit and then had a bigger deficet than all the rest of the presidents combined.

2008 Sep 09 01:58 PM

[StateofConf...:]

When we say the taxpayers are bailing out these institutions, I have to ask who are these taxpayers? Present taxpayers are certainly not doing it, in fact the moment any candidate hints at raising taxes, the Republicans will print attack ads and tell you the world is coming to an end. What they don't say is they made it end.

First and foremost, we need a simple tax code. Stop interest deductions for houses, tax income and property of churches and get some of that overblown salary the CEOs and Wall St. insiders are stealing.

Remember this for the election, would you trust the judgement of anyone that voted for Bush twice?

2008 Sep 09 11:56 PM

[chennian:]

what a country. virtually buying houses for every citizen.

2008 Sep 10 01:55 AM

[bearfund:]

mcadoo3312, if you haven't found the bull market/bubble, you aren't looking very hard. Here are some hints: $TNX, $TYX, TLT, IEF. Yes, I'm short, and I expect to turn an enormous profit when this thing blows up.

2008 Sep 10 11:16 AM

[ronindoe:]

i believe, in my naive way, that if large companies fail because of their business practices, then they should go the way as small businesses, under. Who is there to help the small business man when his company tanks or makes bad decisions. I know this is a little different with these mortgage companies and a lot more is riding on them than the survival of a small business, but the same ideals should hold true: competition in the market will create and destroy companies that have or don't have what it takes. Fannie and Freddie should have been all private or all public. Their hybrid status left accountability to sort the mail.
As for aiding the car companies, the gov't should leave them alone also. Allow for creative competition to spawn new ideas. The large players have had their chance. Even when in cahoots with lawmakers, having loads of cash dumped on their driveways, they still can't pull off the flexibility and innovation needed of new markets that smaller players can. Allow the market to fix these top heavy companies, by either bankruptcy or downsizing unprofitable lines.

2008 Sep 14 05:30 AM