Sunday, July 13, 2008

The Authorities haven't closed the market down but have let the New York Times know in the last few minutes that the Bush administration will ask Congress to approve a rescue package that would give the government the authority to buy billions of dollars in stock in Fannie Mae and Freddie Mac and also lend to the companies to meet their short-term funding needs.

In concert the Federal Reserve voted on Sunday to also open a lending facility for Fannie Mae and Freddie Mac, if they need emergency capital. The two companies would be able to post their own securities as collateral.The plan apparently asks Congress to give the government the authority over the next 2 years to buy an unspecified amount of stock in the two companies.

Simultaneously it would permit the companies to have greater access to the Treasury, by expanding the credit line that each company has from the Treasury. Each company now has a $2.25 billion credit line, set nearly 40 years ago by Congress. At the time, Fannie had only about $15 billion in outstanding debt. It now has total debt of about $800 billion, while Freddie has about $740 billion.

The 2 companies also hold or guarantee mortgages valued at more than $5 trillion.

This will require an immediate lifting of the national debt limit which requires Congressional approval . It will ask Congress to give the Federal Reserve a role in setting the rules for how big a capital cushion each company must hold which they think will re-assure markets.

When President Bush took office five years ago, the national debt was at $5.6 trillion; it was increased for the 5th time in his Presidency on September 27th last year 850 billion U.S. dollars to 9.815 trillion dollars by a vote of 53-42 . Last week it stood at over US$9.39 trillion, or US$124,400 for a family of four. Interest payments on the debt are already 9.5 % of all government expenditures.

An official statement is expected some time later

The Bush administration wants a fast reolsution and want Congress to adopt the plan immediately.

Last Friday, the Senate approved a measure that will form ther basis of the Amdiminstartions plans .

This "surprise" announcement is intended to send a sharp signal to both stock markets and debt markets that the government was standing behind the mortgage companies.

The credit line provided by the Treasury to the companies has always been seen by the market place as evidence that the two companies would be rescued by the government if they ever encountered severe financial problems.

This is despite years of denial by leaders from the Federal Reserve and to officials from Republican and Democratic administrations has denied the existence of a so-called “implicit guarantee.” Those who denied the existence of the guarantee included Treasury secretaries Robert Rubin, Lawrence Summers and Henry M. Paulson Jr., and Federal Reserve Chairmen Alan Greenspan and Ben S. Bernanke.

The implicit guarantee was a useful device both for the companies and the federal government. It has enabled the companies to get money in the debt markets at rates far lower than other companies and close to the same as treasury securities. At the same time, the Federal government did not have to record on its budget any significant liabilities for the large subsidy it was, in effecting, providing to the companies. Yet it also raised concerns among critics, who said it was unfair to rival companies and that it promoted a management laxity since executives knew that the companies could always count on a hand from the government if they began to falter.

Motivating the change was the central role of the two institutions and the depth of ownership in the paper they have issued. Every major bank, and many mutual funds and pension funds and foreign governments, hold significant amounts of securities issued by Fannie and Freddie, which have been viewed over the years as being almost as safe as treasury securities. A default by either one of the companies could be catastrophic for the financial system.

No mention of Lehman Bros. Nor of closing the market for a day , which would seem sensible until this plan is actually enacted.

PS : Apparently the Commander in Chief ducked announcing this grand plan of showering money on Wall Street and left it to Mr Paulson (Ex CEO Sacks of Gold) to talk to his own, from the steps of the Bell Tower entrance of the White House.

For those seeking a straightforward brief account of the role of Fannie Mae and Freddie Mac there is an excellent piece in the New York Times today by Peter Goodman - Government as the Big Lender