Weekend Thinking: An Agency Recapitalization Proposal

Includes: FMCC, FNMA
by: John Jansen

I had a conversation with a research analyst at a large investment bank whose purview is the GSEs. This particular gentleman believes that a direct government bail out of Freddie Mac and FNMA is an unlikely government event. He posits that it is an unlikely event at the outset of this episode and ,if necessary, would only play out much further along in the process .He suggests that Hank Paulson is flipping through his Rolodex (much better than a Blackberry) and he is busy stitching together a plan which would require money from other large banks , central banks and private pools of equity capital from around the globe.

In his view the losses which the GSEs will suffer over the next 2 years will be in the vicinity of 40 billion to $50 billion and that could be handled without direct intervention by the US.

He would alter his view if the peak to trough decline in house prices is greater than 30 percent. In that event losses would be larger than the aforementioned range.

In his scenario, the deal would significantly dilute the current equity holders as well as those who hold trust preferreds. Trust preferreds are ultimately equity and in his view they would likely be toast.

He believes that the deal might be designed in such a fashion, that over a longer time frame, (several years) current common and preferred holders might share in the booty if when the GSEs become profitable again. He does not see that happening before some time in 2010.

Regarding subordinated bondholders, he thinks that they are likely to survive intact as long as agreements and covenants currently in place regarding mandated capital levels are maintained.

So if this fellow is correct it might be another interesting Sunday night in Tokyo.