Smart Borrower Blog

The Other Shoe Just Fell

Sep 8th, 2008 @ 3:56 PM by Alden Smith

If you have followed my meanderings for any time at all, you have seen the concern I have for the fate of Fannie and Freddie. Even though I am no economic analyst, the rest of the news I get on a daily basis does keep me informed, and I knew that sooner or later, they would fall. Fall they did. Sunday, the Fed announced that they are taking the pair over.

Treasury Secretary Henry Paulson, in an interview on Monday, said the takeover was designed in a way that would protect American taxpayers. Huh? Who is getting stuck with the bill? Surely, the people who hold common and preferred stock are not happy, because the Fed comes in over them, making their stock absolutely worthless. That is a bad enough deal to begin with.

Although Paulson places the blame on this bailout on the downturn in the housing market, you have to know that there is a great deal more to it than that. For one, foreign investors hold a lot of the securities that the pair has bundled together. It would not be in the best interest of foreign relations to leave these investors holding the bag. And as much as we hate to admit it, their outright failure would certainly create more financial turmoil than the country could bear right now.

We have known about their troubles for over four years. There have been questions about the accounting practices that would give anyone pause. Treasury Department officials and executives from Fannie Mae and Freddie Mac had been discussing threats to the firms for the past four weeks. Things came to a head last week, though, when the companies’ regulator sent a letter that listed the many reason why the companies should be taken over. It changed the mood of the talks into meetings with an adversarial tone. The top execs were called on the carpet by FHFA Director James Lockhart, who gave the pair their marching orders.

Things proceeded then to the announcement Sunday. CEO’s Mudd and Syron have of course been dismissed. There had already been some bloodletting at the companies in good faith of showing that they were making an effort. The Fed has made F&F stop paying dividends on stock, and plans to allow investors to hang onto stock in case there is ever a chance of recovery. The Fed will hold “senior” shares that give them first go at the pair.

We now see a pair of industry giants that are now truly backed by the Federal government. No one can question the reality of whether or not the government really does back them – they now certainly do. For all the stockholders and institutions that hold shares of F&F, things look a bit grim. This is a bad thing for them, but a good thing for the country. It is about time that the pair was brought to task. Let’s hope that this takeover proves to be fruitful to the mortgage market.

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