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  1. If I’m reading it right, the agencies will fund directly through the Treasury. I’ve been suggesting this for many years. This lowers the cost of funds for housing, the point of the entire program, by removing a premium that’s been paid by the lack of an explicit guarantee.
  1. Agency portfolios being phased out, to be replaced by direct purchasing of the MBS (mortgage-backed securities) by the Treasury. This has no real implications for the non government sectors, just accounting on ‘their’ side of the ledger. But it does mean lending can continue and funds will be available for all eligible borrowers.
  1. Some kind of government preferred stock coming between profits and the remaining shareholders of various classes. This should leave stocks with some value depending on actual portfolio losses, unless I’m missing something.

I’d guess most markets have been pricing in worse outcomes than this.


8 Responses

  1. Warren,

    I asked a question this morning on the Mike Norman show.
    Could you please explain how Freddie Mac, and Freddie Mae
    What branch of the government is in charge of assuming the debt.?
    Or is the government just going to try to sell the bad debt to foreign soveriegn funds, foreign central banks, and investment banks.

    Why didn’t the government just cover all the bad mortgages, and remove all of the bad debt from the balance sheets of the the banks in trouble.

    Who is really going to benefit by this bailout?
    Treasury Paulson’s cronies? Certainly not the people who own homes that are still losing value, or who are delinquent with bad credit.

    My question will the assumption of the 100 billion of debt for both
    FNM and FRE, cause inflation to increase?

    Lets say that another 300 billion is assumed by the gov.
    Will the chinese, and japanese continue to buy our debt to fund the bailout?
    Were they going to stop buying the debt. if the us government didn’t take the action of almost taking into recievership?

    your thoughts to clarify my confusion required.
    I want to benefit from the changes in my trading etc.
    I want to understand this situation.
    Can you help?

    Bob F.

  2. Think of it this way.

    The agencies simply sell securities in the market to raise the funds they use to make home mortages to individuals as is their charge from Congress.

    The cash flow from the home mtgs more than pays for the securities as the mortgates are issued at higher rates than the securities.

    So it’s a ‘matched book’ for the most part, though not a perfect match regarding maturity and optionality, but that’s another story.

    Projected losses on the outstanding mortages suddenly threatened their ability to pay off the securities they issued.

    This carried the risk that they could no longer sell securities and, therefore, no longer make more mortages- something Congress doesn’t want to happen.

    Last I saw even with the losses on the mortages there was probably enough cash flow left over to be able to pay off the securities outstanding. Some will argue that the mortgage losses will be much higher and there won’t be enough cash flow to cover the securities. They may be right, particularly if the agencies were allowed to fail.

    Instead, the US Treasury has taken over the funding of the mortgages. Functionally, they will issue Tsy securities and use that money to make the home mortgages. There is no funding risk for the Treasury. The risk for the Treasury is that the cash flow from the home mortgages they make will be insufficient to service and pay off the Treasury securities. Since the mortages are issued at a higher rate than the Tsy secs, there would have to be even higher losses on the mortgages issued for the Govt to ‘lose money.’ While this is a possiblity, it is far more likely the govt. will make a profit on the spread.

    So more towards you question, there is no agency ‘bad debt’ outstanding. There are home mortgages outstanding that the agencies insure, and the govt. has said it will provide capital as needed to the agencies to cover any losses on the mtgs in excess of the interest rate spread and in excess of the agencies current reserves.

    As above, it is unlikely this will be necessary, but it might if home prices fall a lot further and there are larger losses on the agency mortgages to individuals. I’d bet the Tsy winds up with a profit.

    The Tsy got a big pice of the residual profits in return for doing the funding and taking the risk. This greatly reduced anything that may be left over and go to the various classes of shareholders.

    hope this helps!

  3. Warren,

    Thank you for explaining clearly how the system is supposed to work.
    Please comment on the article below from Jim Rogers CNBC.
    Do you think he is correct?

    Why didn’t the government ask the shareholders of Freddie and Fannie for approval before they unilaterally decided to take over? To me that action is no different then Russia taking over BP assets?
    Is it true that a few rich people are getting away with screwing the system and taxpayers over? Are crooks getting away with breaking the law? How come no one is in jail? Seems to me this whole mess was a huge ponsey scheme similar to ENRON, Worldcom etc. What is the morale way to solve this problem, versus what will actually work? Your thoughts please?

    Here is Jim Rogers statements below:
    The nationalization of Fannie Mae and Freddie Mac shows that the U.S. is “more communist than China right now” but its brand of socialism is meant only for the rich, investor Jim Rogers, CEO of Rogers Holdings, told CNBC Europe on Monday.

    “America is more communist than China is right now. You can see that this is welfare of the rich, it is socialism for the rich… it’s just bailing out financial institutions,” Rogers said.

    Stock markets jumped after the U.S. government’s decision to launch what could be its biggest federal bailout ever, in a bid to support the housing market and ward off more global financial market turbulence.

    But Rogers said in the long term the move spelled trouble.

    “This is madness, this is insanity, they have more than doubled the American national debt in one weekend for a bunch of crooks and incompetents. I’m not quite sure why I or anybody else should be paying for this,” Rogers told “Squawk Box Europe.”

    European stocks soared on Monday, led by banks. UBS was up 11 percent, BNP Paribas up 8 percent, Credit Agricole up 11.1 percent and HBOS up 13.8 percent.

    “You certainly gonna see a huge jump in any financial institutions which owned a lot of Fannie (NYSE: fnm) or Freddie (NYSE: fre) … because they don’t have to worry about going bankrupt all of a sudden,” Rogers said. (Watch the video on the left for the full interview)

    “Bank stocks around the world are going through the roof, that’s ’cause they’ve all been bailed out. You don’t see the homeowners in Kansas going through the roof ’cause they’re not being bailed out,” he added.

    “A Huge Mess”

    However, despite the rally in Asian and European markets, the decision to take over Fannie and Freddie is likely to cause more volatility and needs careful consideration by investors, according to Rogers.

    It’s rarely good to jump in a moving bus and right now you got a lot of buses moving. I might short some more investment banks in the US, depending on how they rally over the next week, but other than that, I’ll just sit and watch,” he said.

    Rogers, who is short on U.S. bonds, said these are likely to fall while commodities may rally. The two government-sponsored enterprises don’t have good loans on their books, because “everybody else took the good stuff and dumped the bad stuff onto Fannie and Freddie,” he said.

    From 2010, Fannie and Freddie will have to shrink their portfolios by 10 percent a year until they reach $250 billion, to reduce the risk to the taxpayer, according to the Treasury plan. But this may put additional pressure on the housing market, Rogers said.

    “That’s going to also ensure that house prices continue to go down. It’s going to be harder and harder to get a mortgage.”

    Investors should not pin their hopes on this year’s presidential election for a solution to the problems, as none of the candidates is likely to find one, Rogers said.

    “This is a big huge mess and neither one of them has a clue what to do next year. It’s going to be a mess.”

    your thoughts please as you make sense

    Bob F.

  4. I had dinner with Jimmy way back. He misses a lot of macro monetary points and doesn’t understand monetary operations. It’s just not his strong point.

    Functionally the agencies already were public institutions. That’s why their debt sold at such relatively low yields. Not as low as the Tsy, but lower than any private corporation with similar capital ratios and leverage.

    So, functionally, nothing has been added to the ‘national debt,’ nor is the point of govt. to minimize deficit spending. Nor does this in any manner alter the solvency and nominal spending power of govt, which remains infinite.

    What Paulson did by moving the funding of the agencies to the tsy is fully remove liquidity risk form public institutions that never should have had liquidity risks from inception, as a matter of the public purpose for which they were created.

    If Jimmy has a beef, it’s with the original formation of the agencies, and their public purpose of promoting home ownership to moderate income households, not with the latest ‘adjustments’ to sustain the program and continue to support moderate income borrowers.

    He is probably right that this will contribute to higher interest rates, as once ‘market functioning’ is restored with GDP muddling through at positive levels, the Fed is likely to get back to what it considers a neutral rate as quickly as possible, presumably to avoid creating the next ‘bubble.’

  5. Warren, after a day like today, what’s your big picture view of where the market is going from what you’ve been seeing and hearing? Is this beginning of ‘the end’, or the beginning?

  6. “Nor does this in any manner alter the solvency and nominal spending power of govt, which remains infinite.”

    Sadly infinite power corrupts infinitely!

    Warren the problem for me with this BEAST we call gubbment is that they have so many LAWS and RULES, and the more they can spend, in essence the more POWER they have and the more LAWS AND RULES they can impose upon me. Almost daily I now have runins with authority figure types who are not pleased with how I did this or did that. Often I have gotten in much trouble with policemen types, city marshals, park rangers, traffic cops, etc etc because I didn’t follow the RULES, and I explain to these people how the heck can I? Really, I ask them all to tell me can they give me all the fed, state, and local rules, all the hunting rules, all the fishing rules, all the boating rules, all the airplane rules, all the traffic rules, of course they cannot, and often they tell me ignorance is no excuse for breaking the law and write me a ticket or arrest me, but goddamnit warren, how can I keep 5 billion lines of LAW enforced by the gubbment in my head and follow all the rules when they don’t even know them all? My friends for years used to go get lobster during lobster season in key west, well they changed the rules, my friends from canada didn’t know that so they got ticketed by the game warden, I can give millions of examples like this. I was at a park near sarasota/sanibel – for years you could make your own fire with your own wood, well last year they changed the rules, and you had to use specially cut wood the park provided and couldn’t use your own, I didn’t know – the park ranger kicked me and my canadian friend out of the park for breaking the RULES! Oh god could I go on and on and on. I try to talk like a human being to these gubbment agents the state has decided is better to give busywork to then let them hang out and idle – but they are so scared they will lose their gubbment job sucking on da states tit they have become ROBOTS and lost any human compassion that was left in them – they cannot be reasoned with – they don’t care that they don’t know all the rules or you don’t either – but if they catch you breaking a new rule they DO KNOW about you are going to fry – like the cops from that movie THX1138 – and you talk about giving them more power to spend and make more robot cop authority types, I think this is why rome died, people got sick of all the gubbment rules and regulations.

  7. “This carried the risk that they could no longer sell securities and, therefore, no longer make more mortages- something Congress doesn’t want to happen.”

    They could no longer make bonuses off of selling trash to some dummy in norway who managed the trust fund for the nordic fishing village – his name was Svenson. The bible talked about towers of babel growing too high, in modern military science, you have to accurately guage the logistics of fueling a war machine half way cross the world – a good general keeps it all efficient and good for the whole borg. How can Vinnie the gangsta in new york know the low life crook in iowa who is being given a loan so it can be securitized and sold to the sucka in norway is the best thing for the local, regional, national, or global good will of all human kind? The chain of people from iowa to new york to norway has too many weak links and it only takes one to break the chain. Fleetwood mac sang about not breaking the chain. Globalization is not a good thing sometimes, you lose perspective, you can’t see the tree for the forest. If you come along and give some human the ability to oversee the whole forest and dictate its growth and direction – he gets a lot of power, and absolute power is a good thing right Warren?

    I like being a tree, not some PRISONER patrick mcgoohan number in the forest, what is your number Warren?

    The government may not lose money, and may gain a lot of money, the agents of the government like paulson have how much money and will get how many bonuses from this? When you and me and hank paulson go into a bar to buy the cute girl a drink, who is left looking a chump going home a lonesome loser? Why did God create the garden of eden with just adam and eve – why didn’t he fill it with 100 zillion people? More is better right? Quantity trumps quality. I am not smarter than the lord Jehovah, maybe he knew something about population density levels that has escaped our modern intellectual policy makers.

    “The Tsy got a big pice of the residual profits in return for doing the funding and taking the risk. This greatly reduced anything that may be left over and go to the various classes of shareholders.”

    I know my small town banker friend hates the big ole gubbment and their loans (that he says he can’t compete with) and the big hank paulsons at the top who have hundreds of millions – he wants to completely change the CENTRAL aspect of gubbment that lets hank paulson types amass so much money and power, he had me watch this show called Andy Griffith, and whenever those big gubbment boys came in from Raleigh, NC to little mayberry, things always got wonked.

    I agree, why is Rogers paying for stuff he thinks is stoopid? He should stop paying, why doesn’t Rogers stop paying? What is he afraid of? Why live in fear? That is no way to life, liberty and happiness is it Warren? Constantly living in fear some thug brute with a gun will shoot you or lock you up if you don’t go along with the stupidity of the masses – how pathetic Rogers keeps paying – will you please tell Rogers to stop paying – to be a leader and an alpha male instead of a wimpy whiner. Warren did Rogers ever read about the founding fathers or the boston tea party, why doesn’t he stop paying his taxes like they showed him if he is so pissed off? What a hypocrite jimmy rogers is, he is so pissed at the markets, when the real problem is that box the markets are in, it is a concrete block sinking jimmy rogers and he is too scared to cut that block like the founding fathers showed him but will whine till he is blue in the face about the markets within that block!

  8. Rob,
    A risk was removed, but not much may have been added if the tsy limits agency lending. so far that’s not an issue, but could be.


    I hear you!

    And govt here is only about half what it is in the eurozone and elsewhere!

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