This was first written last week, before the crazyness that happened on Monday.  Updates about everything else will come later in the week.

What Happened?
On Sunday, September 9, Treasury Secretary Henry Paulson pulled out his figurative “bazooka” and fired it down the street to Fannie Mae and Freddie Mac (henceforth referred to as “the Frannies”, “the GSEs“, “F&M”, “F&F”, “M&M”, “Frack”, “Mac Daddy”, or “Ms. Mary Mac”).  The federal government took over the two companies.

How Did The Feds Take Frannie Over?
The same way they take anything over.  The President authorizes a “security team” without Congressional approval.  No.  Congress granted the power to Paulson, this is what Paulson referred to as his “bazooka”.  Hoping that merely the presence of the bazooka would negate the need for it.  So much for that.  Paulson took the keys to the building and passed them over to the Federal Housing Finance Agency (FHFA), a brand new agency created by the same bill that gave Paulson his big gun.

What Did Paulson and the FHFA do Next?
henry paulson fannie freddie takeoverThe first step was called a capital infusion.  The Treasury Department will essentially buy preferred stock at the price of $1 billion for each GSE.  This means both companies now have a fresh billion smackers to help back up their dire need for cash.  Because buying preferred stock from other shareholders won’t give the companies any new cash, the GSEs must issue new preferred stock.  This dilutes the value of current preferred stock (held mostly by other banking institutions).  The current owners of preferred stock will lose some value.  This does mean the government has thrown tax payer money to save what is essentially a business.  If the business fails, we could lose our billions.  However, common stock holders, and other preferred stock holders will take the brunt, with bond holders and the government getting most if not all of their money back if the companies are disolved and assets sold.

And Then?
The FHFA, headed by James Lockhart II, placed the Frannies into conservatorship.  This is similar to bankruptcy, but only in legal terms.  It doesn’t mean the companies are dead, and you can still buy their stocks.  However now the goal is survival, not profit, so shareholders would have to wait a long time to reap any potential rewards from their investment.   Dividends have been eliminated.

Otherwise business continues as normal.  The FHFA replaced the CEOs, and the agency will serve as the board of directors.  Thankfully, the intense lobbying done by both GSEs has been given the axe as well.

The Treasury will serve as a business partner in the matter.  A line of credit up to $100 billion will be available for the Frannies to use at FHFA’s discretion.  Additionally, the Treasury will buy certain mortgages just like any other investor would.  Since most mortgages are safe, the Treasury will get a return on this investment.  The line of credit will be paid back with interest as well.  The entire point of these moves is to lighten the load of the Mac Daddies because they are too important to fail (according to the government).  Over the next few years both companies will reduce in size, allowing other private entities to step into the business.

What is The Weakonomist’s Take?
Its a shame this move by Paulson had to be done, but I guess it had to be.  This will be the perfect case study for how the government can step in to make the market react faster than it normally would with stability to boot.  Had we let them fail, the companies would be liquidated a new firms would step in to takeover the role of buying and re-selling mortgages.  However it might have taken a decade to get done, all the while the morgtage industry might come to a halt, which could throw us into another Great Depression.  What Paulson did was the “better safe than sorry” approach.

The goal is the same as my scenario above though.  We, and by we I mean all banks, government, and shareholders of the GSEs, let the companies get too big.  You can’t rely on one thing too much, because if that one thing breaks we all fall down.  We relied on the Frannies way too much to keep us propped up, and it wasn’t enough.  The reliance will be decreased significantly over the next year.  I blame Orange Face, not because its his fault, but because he still scares me.

What Else Happened?
The stock prices for these two tanked.  In mid 2007, Fannie Mae was hanging out in the upper $60s.  It tanked to below $10 by July.  After the announcement of the takeover, the stock is trading around $1.  The stock market in general liked the news, especially banks.  This means the mortgage business can keeps its focus on fixing their own problems, instead of worrying how they’re going to sell the new mortgages they originate.

Any Conspiracy Theories?
tin foil hat conspiracyI haven’t heard any, but I did think of one.  Please keep in mind I created this and don’t believe it myself, but it is fun.  Its no secret China owns a lot of US debt.  A good portion of it is in US Government debt and the bonds of Frannie.  If China ever wanted to destroy the US economy, they could flood the bond markets with their holdings, making the values of the bonds tank.  This in turn would destroy our dollar.  China would lose lots of money too, but would be hurt less.  My conspiracy is the Federal Government knows this, and so China told them to go in and take over Fannie and Freddie to China’s wealth stays pure.  Its fun to play around with but highly unlikely the Chinese pulled this stunt.  We’re smart enough to know when to step in.

Below you can read various articles about the takeover.  The most comprehensive (and boring) version is Wikipedia’s.

Chicago Sun Times
USA Today
MSN Money


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categories: banking, business, economics, government, loans