Will The Bailout Create New Fannies and Freddies?

The Emergency Economic Stabilization Act of 2008 could turn into a massive bailout program for municipalities and counties that have seen their revenues “disrupted by the current market turmoil,” and it could create new Fannie Maes (FNM) and Freddie Macs (FRE).

And if passed as written in the “Discussion Draft” released Sunday, the Act could become a national rent control program for tenants in multi-family housing units whose owners were behind in their mortgage payments. Under the Act, Treasury would be required to try to “permit bona fide tenants who are current on their rent to remain in their [rented multifamily] homes under the terms of the lease.”

Aggressive attorneys would argue that the tenants could remain in their homes under the terms of the lease beyond expiration - forever. That would effectively impose rent controls on those properties, which would be owned by the Federal government. If so, the government wouldn’t be able to sell those properties to investors who wouldn’t look at properties with rent controls. The preferred interpretation and the undoubted intention of the Act is that the tenants would be able to live in the homes under the terms of the lease until it expired. But the act doesn’t say that, yet:

[Administrators in Treasury would be required to take into consideration] the need to ensure stability for United States public instrumentalities, such as counties and cities, that may have suffered significant increased costs or losses in the current market turmoil.

Define “significant.” Wow! Chicago’s Mayor Daley would walk through that door many times, along with every other big city and Walissa-sized town in America. Can you spell “trillions?”

The Discussion Draft of the Act would directly reward professional money managers at banks, mutual funds and pension funds who mismanaged their investments in Fannie Mae and Freddie Mac. These so called pros held on to the stocks to the bitter end, watching their prices go to nearly zero. They should have sold at the first sign of weakness, but they were too smart for that. These folks are buy and hold “investors.” What losers! The act would effectively nullify the mark to market accounting rules for institutions with less than $1 billion that had their assets cut by the Fannie and Freddie takeovers by the government.

The reasoning behind this aspect of the bailout apparently is that the Federal Reserve Board and other banking regulators encouraged, if not insisted, that banks buy FNM and FRE because those stocks were “safe.” Apparently Congress thinks that the government has to pay for giving bad advice to those smaller institutions.

So the blind regulators were leading the blind bankers.

Such institutions that serve “low- and moderate-income populations and other underserved communities” should be included in these bailouts under the draft of the act released Sunday.

Question: By bailing out banks that serve these populations, is Congress creating new Fannie Maes and Freddie Macs? Apparently.

Meanwhile, the act calls on the government to take into consideration “maximizing overall returns and minimizing the impact on the national debt” as it buys and sells troubled mortgage backed securities and other securities while implementing the Troubled Asset Relief Program, or TARP.

Does this mean Treasury must buy troubled MBSs low and sell them high, even if the institutions that sell low have to write off their losses? If financial institutions had to write off their losses, that would undermine their balance sheets. It would hurt their ability to borrow from other financials, make them less profitable or unprofitable and reduce their income tax bills. This wouldn’t help minimize the national debt.

On the other hand, such transactions might save the institutions from liquidation, making it possible that they may survive to pay taxes sometime in the future.

As for buying troubled mortgage assets from distressed financial institutions, the act could turn even healthy banks like J.P. Morgan Chase (JPM) and Wells Fargo (WFC) into distressed ones. All the Treasury Dept.’s new Office of Financial Stability would have to do is assume that a financial institution with good prospects for long-term viability would become a poor prospect for long-term viability if the government didn’t buy its MBSs or other impaired securities and that buying its MBSs would be “the most efficient use of funds under this Act.” Then it could buy from anybody, subject to reviews by various oversight boards and the courts.

Professional money managers of pension funds and other retirement funds who were sitting with troubled MBSs also could be rescued. Imagine the money that might be poured into the teacher and state employee retirement funds of, say, California [CALPERs], Texas, New York and other states? Can you say “trillions?”

Overall, there are so many wide open obligations that the government might have to undertake under the Discussion Draft of the Act that it’s impossible to estimate how much the government might have to invest in bet on troubled mortgage backed securities.

Here’s a potential partial out for taxpayers and the government. The mere existence of TARP may be enough to reopen the frozen credit markets. Banks have been refusing to lend to each other because they didn’t trust the “long-term financial viability” of their trading partners.

A sentinel effect of TARP may open the markets enough that owners of troubled securities could sell them to vulture investors and other private speculators. Compensation restrictions that would cover the five top senior executives in a financial institution that sold securities to the feds would encourage them to sell to private speculators instead of making the Treasury be the speculator.

But under the Discussion Draft of the Act, compensation restrictions would apply only to publicly-owned companies, not to municipalities, counties or pension funds. Executives of municipalities and tax-exempt pension funds would have no incentives to sell to private speculators instead of to the government and taxpayers.

No wonder GOP members of the U.S. House caucused for so many hours Sunday afternoon. Some of them must have seen the still huge problems with this bill. This bill may not come to a vote Monday as scheduled, if Republicans balk at some of the costly provisions noted above.

And if less than half of Republicans in the House vote for the bill, it will be understandable and potentially fatal for the bailout Act.

Then, watch the markets react. It won’t be pretty.

P.S. I’ve only read the first 30 pages of the Discussion Draft.

Comments

[Jimmy Lathrop:]

Thanks for pointing out that little provision bolstering local rent regulation. Now I can run to the District Court for a stay of a Housing Court decision if it is adverse to section 109. I can also drag a building owner into district court if they don't have the necessary funds to maintain the property. Have any of you been inside a Federal District Court lately? They have cafeterias and the food is usually much better than the food served around the State Courts. Thanks Hank! XOXO!

2008 Sep 29 08:06 AM

[messy:]

I would say the general public does not have to worry about this article and whats in it. Since the house of representatives voted it down it seems as if Q-public...does not like it. What do they want? Maybe its some of those CEO's and Wall st. crooks to be put in jail for ten years or at least stand trail.

2008 Sep 29 07:02 PM