Treasury takes over Fannie and Freddie

Good afternoon everyone!

Whoa! Sorry this is taking so long. There is a lot to digest here. This is very complicated! Here are a series of links that summarizes what happened today:

Paulsons statement this morning from his press conference

Treasury fact sheet on GSE agreement

S&P slashes Fannie/Freddie preferred to junk status

Fannie/Freddie taken over by U.S. government to prevent collapse

My Take:

There is too much to highlight from above so I will just try to summarize my thoughts here. This is basically a giant cluster f*ck. Paulson took no Q&A after his statement and there are many questions that need to be answered.

Highlights to note:

- The preferred and common stock are now pretty much worthless. The Treasury has issued themselves their own preferred stock which is first in line ahead of the old preferred and common. This means the common and preferred take the losses before the Treasury preferred does. We all know more losses are coming since these companies were bleeding red so you can kiss both of these stocks goodbye.

The dividend on the preferred was also eliminated. I expect this stuff to be trading at $1 a share or so Monday. Its essentially worthless.

- Establishment of a new secured lending credit facility for GSEs incl. FHLB, intended to serve as an ultimate liquidity backstop (temporary authority expires in December 2009)

- The Treasury basically guaranteed the $5 trillion in debt. It did not specifically say so, however they did say that both GSE's are fully backed whole by the US government. They basically "passed the buck" here to the next administration when it comes to the details. Paulson explained that a decision needs to be decided on this before the end of 2009 when the balance sheets of the GSE's start to get leveraged down(see next paragraph).

- They established stock purchasing agreements to protect the American taxpayer. So if they make money down the road, some of its coming back to us after we pay for this disaster now.

The new GSE structuring is detailed below. This is from the Bloomberg piece from above:

"The FHFA will take over Fannie and Freddie under a so-called conservatorship, replacing their chief executives and eliminating their dividends. The Treasury will purchase up to $100 billion of senior-preferred stock in each company as needed to maintain a positive net worth. It will also provide secured short-term funding to Fannie, Freddie and 12 federal home-loan banks, and purchase mortgage-backed debt in the open market.

The takeover of Fannie and Freddie is the biggest step yet in officials' efforts to grapple with a yearlong credit crisis that has caused more than $500 billion of losses and writedowns. The government is taking an increasing role in financial markets, after the Federal Reserve six months ago provided $29 billion of financing to prevent Bear Stearns & Cos.'s collapse.

Treasury Gets Stock

Under the plan, the Treasury will receive $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie and Freddie. The government will receive annual interest of 10 percent on the initial investments.
As a condition for the assistance, Fannie and Freddie will have to reduce their holdings of mortgages and securities backed by home loans. The portfolios ``shall not exceed $850 billion as of December 31, 2009, and shall decline by 10 percent per year until it reaches $250 billion,'' the Treasury said.

What does it all mean?

That's a good question. Essentially the US Treasury's balance sheet will be used via the FHLB through 2009 to suck up all of the MBS crap that is out there. At the end of 2009 due to systemic risk, they will slowly start shrinking the balance sheets of the GSE's at the rate of 10% a year.

There are lots of questions here folks. The $5 trillion dollar question was answered only indirectly through the governments promise to guarantee the GSE's. Congress will have to figure out exactly how they plan to do this before the temporary FHLB authority ends in 2009.

Who immediately wins here? The FCB's and funds like Gross's PIMCO who were made whole on the GSE debt that they own by the guarantee from the US government on all of these MBS's.

Who loses? Regional banks. Many held large amounts of Fannie/Freddie preferred. This will be yet another loss they must take.

Who could potentially get creamed here? Anyone with level 3 assets. This includes the large banks and especially the IB's. Essentially, what happened over the last few weeks was Morgan Stanley was hired to dig into the financials of the GSE's and clean up the books. Once they saw the numbers, the Treasury realized they were "insolvent" and were forced to take action this weekend.

Who is to say the government won't do the same thing with the rest of the financial institutions out there? It sounds like they want to clean this mess up, and if I were up to my neck in level 3 assets, I would be pooping in my pants right now.

Bottom Line:

Equities might pop, but it won't last. The financials took a big punch in the face this weekend. They were lobbying hard for the preferred to not be touched. For once the government said "take your medicine". The Treasury hopes that loosening up the lending through the FHLB will lower rates and get the housing market going again.

As I have said before this probably won't happen. The bond market might decide to take things into their own hands and take rates higher. Mortgage rates are set through the bond market folks!

I have no idea how this is absorbed tomorrow. I will be watching Asia tonight as well as the currency markets. The dollar could get crushed based upon the Treasury backing of all of this debt. We could see a crash or a big rally tomorrow. One thing is for sure, we still have the same issues of unaffordability in housing and a bad economy.

Any pop on equities will not be sustained.