Lots of talk about the Feds doing something (what we don't know) with Fannie (FNM) and Freddie (FRE). With all of the uncertainty surrounding the survivability of FNM/FRE, it has driven their cost of money up, which in turn has increased the cost of mortgages, which in turn has reduced the number of qualified buyers/borrowers, which in turn leads to lower home prices, which in turn leads to more write-offs at banks, which .... Well, you get the picture.
FNM and FRE have $223b (yes, billion) in short term debts, maturing in September (starting next week). They need to pay this debt off, probably with new debt. But it remains to be seen whether they can borrow this much new money (and at what cost), with the uncertainty hanging over their heads.
The pundits say that if the government intervenes, the common stock will be wiped out. At $5/share, I think that is a done deal ... Even Bear Stearns shareholders got $10/share! But what about the next level of shareholder, the holders of preferred shares? In the pecking order, preferred shares are above common shareholders, but below debt holders. The $64,000 question is, would a Fed action wipe out the preferred shareholders (who are currently collecting dividend yields from FNM/FRE in the range of 16%)? Would the Feds wipe out the equity of $36b of preferred shareholders?
Now, before you all say "don't bailout the preferred shareholders," many of those shareholders are banks, and the preferred shares represent as much as 16-34% of some banks tangible capital (GBTS, MBHI, WABC). In the case of Sovereign Bancorp, we are talking about +$800m of FNM/FRE preferred stock on its books. So if the preferreds aren't bailed out, then it is likely the FDIC will be taking over more banks (another kind of taxpayer funded bailout), as the banks' balance sheets are devastated with the writeoff of their preferred FNM/FRE stock holdings.
Paul
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It is not just banks. Insurance companies also own a LOT of these shares too. So, again, pay me now, pay me later. If the Insurers take a loss, it will be felt later in rates. Insurance is funny like that - the best time to sell insurance is right after a disaster: pricing firms considerably and is generally much more profitable.
So if the preferreds aren't bailed out, then it is likely the FDIC will be taking over more banks (another kind of taxpayer funded bailout)
The point you draw about more banks likely failing if the govt. doesn't back up Fannie stock is a good one, but actions by the FDIC aren't direct bailouts in the same way that the Treasury or Fed backstopping Fannie would definately be a direct bailout (pure taxpayer money). At least banks pay into the FDIC.
We all know that bailouts are bad, they're not sustainable long term, they encourage and reward risk, etc., but we choose to live with them because we think the alternative would be worse. The alternative is only worse if you choose to think short term. Long term, the total net impact of bailouts is far worse than the total net impact of simply letting big institutions fail. But it can be expected that no policitian would ever opt to let a big instution fail on their watch. Thus, we choose the path that perpetually delays the pain.
PR: I don't disagree with your points and you know that I don't profess to have any answers. But FDIC has already made contingency plans to get additional money from the Fed when she runs out of "insurance" money.
I cannot forget Japan's 1990ish decision to not let big institutions fail ... contributing to what I personally believe has been an almost 20 year recession in Japan. With the Nikkei stock index currently at 13000, it is essentially unchanged from its 1986 price.
I would much rather see the trillion dollars we will spend bailing out multi billion dollar corporations be used elsewhere.
Let the corporations fail, let the investors be wiped out.
Take the money we would spend on bailing them out and invenst in alternative energy cources. Create 100000 jobs building windmills and solar panels.
At least we would get something from that.
Plus not all banks would fail in fanny and freddy went under. Sure some would, but others wouldnt and the fdic would only have to take over the ones that failed. And they could get some of that money back as the company is liquidated.
But one thing is for sure, Fanny and Freddy will not fail before November, and probably not until February, just in time for the new president to get the blame.
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