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Winners & Losers at Fannie & Fred
09/11/2008 12:00 am EST
The dust is clearing from last weekend's dramatic takeover of mortgage giants Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) engineered by Secretary of the Treasury Henry Paulson. Investors are still unsure what it means, to judge by the erratic movements of stock prices since the deal was announced.
In a move unprecedented in scale, the federal government will nationalize the two so-called government-sponsored entities (GSEs), which purchase three-quarters of the new mortgages written by lenders in the United States.
The Treasury will put Fannie and Freddie into conservatorship under the direct control of the Federal Housing Finance Agency (FHFA). The boards and chief executive officers of both companies have been replaced. The government will get $1 billion in preferred shares in each company, and has pledged up to $200 billion to cover losses on the toxic loans that brought about their demise.
Starting in 2010, Fannie and Freddie will shrink their loan portfolios to a shadow of what they are today. Meanwhile, Fannie and Freddie's $5.4-trillion loan portfolio now goes right on Uncle Sam's balance sheet, boosting the national debt dramatically overnight.
These numbers are staggering, and so was the swiftness of the government's action. Secretary Paulson moved before the ink was dry on legislation granting him the authority to bail out Fannie and Freddie. Some influential Congressmen were caught flat-footed. Even President Bush waited five months after getting Congress's green light before invading Iraq.
The Treasury Secretary claimed he had no alternative, and the financial media dutifully agreed. The bad loans on Fannie and Freddie's books (accumulated during an insane foray into risky mortgages by both companies) were a dead weight on the mortgage markets and were paralyzing financial markets, too.
And foreign investors, especially governments, who owned billions of dollars of agency-issued mortgage debt, were beginning to unload them and were threatening not to buy more. With America so in hock to foreigners, Paulson argued, what choice did we have?
Although it's still early in the game, there are already some winners and losers in this sad fiasco (although many, many more of the latter, of course). Here's how I see it, starting with the losers.
1. Fannie and Freddie shareholders. The government is recapitalizing the two firms, wiping out their unfortunate holders of common and preferred stock. Besides company employees and individual investors, those include some pretty big names with a lot of egg on their face-Fidelity, Capital Research, Citigroup, and Dodge & Cox among them.
But we must give a special nod to Bill Miller, who manages Legg Mason Value Trust. In 2006, Fortune dubbed him "the greatest money manager of our time," following 15 consecutive years of beating the Standard & Poor's 500. But he continues his descent into investment oblivion with his fund's ownership of 53 million shares in Freddie-a stake he more than doubled recently. That follows disastrous investments in Countrywide Financial and Bear Stearns. His fund is down over 30% so far in 2008. I don't think he's going to beat the S&P this year, either.
Also on the hook: several regional banks-including Sovereign Bancorp (NYSE: SOV)-which own huge chunks of Fannie and Freddie preferred shares, which regulators allow them to count in their capital cushion against loan losses in other parts of their business. Uh-oh. With their capital depleted, some of these banks will be hard-pressed to withstand the additional loan losses in mortgages, auto loans, credit cards, and commercial property that are coming down the pike.
2. US Taxpayers. Does that surprise you? Really? I thought not-I'd like to find a time when taxpayers were not losers (besides tax cuts). Well, get ready for this one, because it's aimed right between our eyes, and it's a big hit-up to $200 billion, so far, perhaps more after Congress gets involved.
Maybe, maybe, if we're very lucky and pray a lot, the losses won't be as bad as people fear. Housing will eventually recover and some of those loans may be sold at a profit, like some of the distressed savings & loans were back in the 1990s. But I wouldn't spend that money just yet.
3. Barack Obama and John McCain. This is the last thing either presidential candidate wants to deal with, given their ambitious spending and tax-cutting agendas.
But as the federal deficit grows with every "rescue" of a failed financial institution, the ability of the next president to get his wish list enacted shrinks. The budget deficit is heading toward $500 billion over the next couple of years, and just as President Clinton had to abandon his middle-class tax cut after his election, the winner of this election will have a budgetary booby prize on his hands.
1. Homebuyers-Maybe. The rescue did accomplish at least part of its mission as rates on conventional 30-year fixed-rate mortgages tumbled after the deal was announced. That means people who have the money and can get banks' approval-two big "ifs"-can now find attractive financing for home purchases. Mark Zandi of Moody's Economy.com says that may limit further declines in home prices, but we still have a long way to go before a recovery.
2. Holders of Fannie and Freddie Debt. Foreign governments that held agency debt (but not Freddie or Fannie's common or preferred shares) have been bailed out by this action. But some opportunistic buyers of that debt made hedge-fund-like profits when the government takeover was announced.
Bill Gross's Pimco Total Return Fund reaped an estimated $1.7 billion in one day after mortgage bonds issued by agencies soared on news of the buyout. The bond market guru, whose record as a forecaster is decidedly mixed, had called for and predicted a government bailout and then put his money where his mouth was by selling Treasuries and other bonds and loading up on agency debt. This time he nailed it.
3. Wall Street. With Bear Stearns history and Lehman Bros. (NYSE: LEH) on the brink, it's hard to see how Wall Street would be winning anything. But check this out, from none other than The Wall Street Journal:
"The intervention could eventually be a boon for Wall Street, by providing a boost to the moribund mortgage industry and by perhaps diminishing the influence of Wall Street's two largest competitors in the market of packaging and reselling mortgage-backed bonds."
And of course, as we all know, Treasury secretary Paulson was formerly chairman of Goldman Sachs (NYSE: GS), and he brought in Morgan Stanley (NYSE: MS) to advise the Treasury on Fannie and Freddie. I'm not accusing either the Secretary or Morgan Stanley of acting in anything but the public interest, and I haven't believed in conspiracy theories since "The X-Files" went off the air. But wouldn't it be ironic if the very people who created this whole mess in the first place wound up profiting from it-at taxpayers' expense?
Howard R. Gold is executive editor of MoneyShow.com. The opinions expressed here are his own and are not necessarily the views of InterShow or MoneyShow.com.
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