lavalyn

Frannie Bailout: Private Profit, Socialized Risk

I agree that this is very bad for the US economy. Effectively, the US Treasury has chosen to make the same bet as the GSEs have. They are wagering on the recovery of the housing market, in guaranteeing the debt of Fannie and Freddie. And here's where things get really bad: if things go well, common shareholders win. If things go bad, the government (and therefore the public) pay more interest and issue more debt.

Frannie Bailout: Private Profit, Socialized Risk

FNM and FRE debt paper. At this point, any deviation of it from US Treasury is arbitrage-able.

Frannie Bailout: Private Profit, Socialized Risk

To be sure, bankruptcy and insolvency hurts all capital holders. I may as well also say that I am a fan of the nationalization of the two GSEs, and am in full agreement that their existence is beneficial to the US and world economies. Where we disagree is whether the taxpayer bailout of these two giants is appropriate.

Shareholders are getting zeroed. Is a zeroing of the shareholders punishing? Certainly. Would the common man be able to get away with that? No, a common man 1) would never be ABLE to get into this situation, as banks do credit checks, 2) would lose much more than their investment. They'll lose their house, their car, everything. Put it this way, if I had any semblance to a government guarantee of my loans, I'd be investing it left right and center, on every investment, high risk or low risk. If a corporation I owned had such a guarantee, it'd practically bet the entire bank on the 00 in roulette. It wins, big bonuses to upper management. It loses, who cares. Seems to be what happened in 2005 for FNM.

The bailout protects debtholders. Should they be protected? I'd be inclined to say no. It is that default risk which keeps securities fairly valued. Do you think it's "fair" that GSE debt traded at a premium to US Treasuries, payouts made to Chinese and Japanese bondholders above US Treasury yields, while being fully backed (implicitly) by the government/taxpayer?

My take? I would have left Fannie and Freddie to its own defenses. Explicitly deny any sort of bailout. Expand Ginnie Mae, which is explicitly backed. If FNM and FRE hypothetically survives that ordeal, so much the better for everybody. But if they're going to be privately held, with private profit, they (and their creditors) should be taking private risk as well.

Frannie Bailout: Private Profit, Socialized Risk

SilverLeaf: the complaint about "private profit, socialized risk" is simply that of moral hazard and double standards. If you or I were to open a business and lose our shirts the way the GSEs have, the banks would stop lending, and we'd probably lose everything... easily beyond shareholder capital.

This bailout is the taxpayer stepping in to cover for mistakes made, which is already dubious... and that's before upper management taking in millions in bonuses, shareholders getting dividends... and them then not giving back. In the interest of "limited liability." The GSEs have been riding the implicit (and now apparently explicit) government backing, while not giving the taxpayer/government any return for it.

Your argument that the public benefitted from the GSEs is irrelevant. Wal-Mart benefits the public, by being a retail store and generating jobs (low-paying, sure, but they likely as a result hire more minorities).

What's Left to Spend in the 'Credibility Bank'?

Or you could say that this is just desserts for a nation that pays hundreds of millions to CEOs that run companies into the ground, millions to professional sports players... and somehow gets paid more for less production than people in China.

The "Chinese worker that make [an] average of $250 a month" produces the things Americans use. The question that it raises is normally phrased "why should the Chinese be paid so little?" when the real question is "Why should Americans be paid so much?"

Financials: Don't Believe the Rumors

You'd be right if you didn't account for these companies' incredible leverage. You're right, FNM and FRE assets are not worth zero... but their decline in recovery value exceeds their shareholder capital. It's mostly surmised that LEH is in the same boat, with Level 3 assets as they are and their off-balance sheet playing with R3 Capital.

Dealing with insolvent companies is a game that's risky to play, both when taking an equity position (it's technically worth zero) and as a client (what's the recovery rate going to be?).