Former economic policy advisor to President Bush, Lawrence B. Lindsey, wrote a downright angry Wall Street Journal editorial (“Hank Paulson's Fannie Gamble”) criticizing Treasury Security Paulson for not making Fannie Mae’s (FNM) and Freddie Mac’s (FRE) shareholders suffer. This comes a day after Former Federal Reserve Chairman Greenspan said the GSEs should be nationalized on CNBC.
Neither Lindsey nor Greenspan have come to terms with the fact that the tone has changed in Washington. Even President Bush was able to control his hostilities long enough to sign the massive housing bill. Paulson has had the difficult job of balancing support for the administration’s free market and moral hazard rhetoric with pragmatic solutions to rebuild the nation’s financial institutions. The Fannie and Freddie situation has gotten dangerous enough for the Administration’s hawks to back down.
Apparently, it is too easy for Lindsey, Greenspan and Poole to play hawk out of office. I remember Greenspan being the biggest dove of them all when he had the power. Now that Paulson has convinced the White House that building confidence is more important than instilling moral hazard, why aren’t these gentlemen cooperating?
What doesn’t Lindsey like?
- Fannie and Freddie can pay dividends will receiving capital from the government.
- No upside for the government similar to the Chrysler warrants.
- No risk based pricing. 3.5% minimum down payments.
- Fannie and Freddie tax to support affordable housing.
I believe that Paulson purposely did not want to destroy the shareholders. Doing so would have not only made it impossible for the GSEs to recapitalize in the public markets, but also destroyed confidence in all financial institutions. Many banks maintain GSE preferred and common stock in their capital base. Even a small haircut in the preferred (as Lindsey calls for) would have grave consequences.
As for dividend, warrants and upside, the Treasury has much more leverage than Lindsey is giving them credit for. The Treasury is now authorized to buy equity and can negotiate any deal they want with Fannie and Freddie. If that’s not potential dilution, I don’t know what is. Even thought warrants might not have been required in the bill, there is nothing stopping the Treasury from requesting warrants with any common, preferred or debt financing.
The new regulator controls the GSE’s capital requirements and portfolio sizes. The regulator can thus either directly or indirectly control dividends. The new regulator can also force the GSE’s to accept Treasury financing on any terms by raising the GSE’s capital requirements.
I do agree with Lindsey on risk based pricing, low down payments and the affordable housing tax.
Give credit to Paulson for being influential enough to turn Bush’s moral hazard ship. Give building confidence a chance to work. Did you notice how successful New York Insurance Commissioner Dinallo has been with the monoline settlements lately, out of the overbearing shadow of the former governor? Paulson could be equally successful with Fannie and Freddie outside of the old Republican shadow.
Disclosure: Author is long FNM and FRE.