The Government's Appropriation of Leverage

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by: Daniel Miller

Since the beginning of 2008, Chairman Henry Paulson and the United States Treasury have taken on enormous amounts of debt in order to contain the housing crisis and prevent a massive failure in the financial sector.  The U.S. taxpayers first saw the effects of a "too big to fail" Treasury mentality when the government-orchestrated bailout of Bear Stearns was announced in March of 2008.  More recently, the Treasury announced the takeover of the two Government Sponsored Entities (GSEs), Freddie Mac (FRE) and Fannie Mae (FNM). 

On September 7, Treasury Secretary Paulson seized control of the two immense finance companies in an attempt to support the U.S. housing market.  The Treasury will begin by immediately taking a $1 billion equity stake in each company, and if needed can inject an additional $100 billion in preferred stock in each company.  Under the announced program the Treasury will begin to buy back mortgage-backed securities later in September, and will have the authority to buy back MBS until December 31, 2009. 

When the Treasury announced it was taking on the debt from Bear Stearns in an agreement with JPMorgan (NYSE:JPM), the U.S. government was taking on the largest amount of debt from a financial bailout since Long Term Capital Management in 1998.  The portfolio of collateralized debt is managed by Blackrock however, and the deterioration of the portfolio's value has been minimal so far. 

In weekly H.4.1 balance reports released every Thursday by the Treasury, the value of the Bear Stearns portfolio is announced.  The first report of the Bear Stearns assets was reported as of June 26, and was valued at $28.9 billion – down from $30 billion three months prior.  The most recent report on September 4 estimated the fair value of the holdings at $29.3 billion, representing only a very minor decline overall relative to the concern of value depreciation expressed by taxpayers. 

Another growing concern for taxpayers, the financial sector, and the Treasury is the stability of Lehman Brothers (LEH).  A growing theme of the current financial crisis is the idea that some financial institutions are "too big to fail" – bringing up the question of whether or not Lehman Brothers fits this profile.  During Paulson's recent press conference where he announced the restructuring of FRE and FNM, he stated that the two were so large that "a failure of either of them would cause great turmoil in our financial markets here at home and around the globe." 

The identification of which institutions can be bailed out because of their potential to intensify the credit crisis is an important and vital role of the Treasury.  This responsibility is one that is of particular importance to all Americans, and the Treasury must always be mindful of balancing the interests of the taxpayer and the necessity of stability in our financial markets. 

Disclosure: none