Market Update September 8, 2008
SPECIAL UPDATE! Sunday’s decision by the Treasury
Department to take over Fannie Mae and Freddie Mac is
shaking up markets and stock indexes are rallying today.
Here’s the scoop!
Fannie and Freddie back about half the total US mortgage
debt, around 5 trillion dollars worth. In 2008 they lost 14
billion in loan defaults and delinquencies. To make matters
worse, an investigation of their accounting practices
has led to accusations of improper accounting practices
within the companies. The concern among many has been
whether the two have enough capital to sustain such losses.
To this end, the Treasury discount window was opened
to them recently so that they can borrow at low 2.5% rates
to offset their losses. Many felt this was not enough.
So even this could not shore up the mortgage giants to the
satisfaction of investors. Remember that many of the largest
investors in this type of debt are foreign. So big losses
are being felt around the world as a result… contributing
to global recession. We are truly members of a “global village”
these days!
This weekend’s decision reflects a solution I had put forth
last year around this time… that the way to help the mortgage
market is for the US government to actually BUY
the MBS’s (pools of mortgages), and thus absorb both the
losses (from defaults) and also the income from all those
folks who continue to pay their mortgages on time. The
end result to taxpayers is that the US treasury may take a
loss to begin with, but then a profit once the crisis clears…
in effect being paid back over time. Initially, credit default
swaps will likely be triggered. This means that current investors
will demand that they be paid in full immediately,
so initial Treasury losses will be felt.
The Treasury will buy 100 billion in Fannie and Freddie
loans. In return the Treasury receives 1 billion in senior
preferred stock, thus becoming a 79.9% stockholder in
the companies, plus 10% in ongoing interest for it’s stake.
The companies are also placed in conservatorship, which
allows accounting and other practices to be revised and
corrected. In the end rates may drop, good news for you.
Will this stabilize the housing market? Stay tuned…