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July 11, 2008

NYT: Freddie/Fannie Takeover Talks Heat Up. Voom Needed.

According to the NY Times late tonight, discussions among senior U.S. government officials have heated up with respect to the U.S. taking over mortgage giants Freddie Mac and Fannie Mae. The structure being contemplated is a conservatorship, which is permitted under a 1992 law, and is one that would essentially wipe out the two firms' respective equity, while allowing their loans to be managed.

Strikes me this is officially crunch time. To put it in Seuss-ian terms, if Little Cat Z is anywhere in the neighborhood he needs to know Things 1,2, and 3 haven't finished the job, and so he should take the Voom out from under his hat. 'Cause we may have gotten the pink cat ring out of the bath, but the resulting pink snow is now everywhere and getting deeper by the minute.

Somewhat more seriously, four things:

1. As the Times points out tonight, most people have no idea the capital at risk here. A 10% decline, say, in Freddie/Fannie assets would be roughly the same -- $150-billion -- as another Iraq war.
2. By taking on the companies' liabilities the U.S. government's total obligations would soar from $9-trillion to $14-trillion, almost certainly forcing U.S. rates much higher.
3. It has always been a canard to say that the companies have the regulator-required capital. Because they do, but the levels are so low as to be meaningless when looked at from a leverage perspective.
4. Most of the loans on Fannie/Freddie's books were done before 2006 and are solid. And even the super-squirrely ones in 2006 and later are worth something, especially with insurance, so try hard not to be terrified by the total numbers involved here. This is going to be a wild ride, assuming a conservatorship happens, but total losses could end up being far less than the doomsters think.

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