Freddie and Fannie's stock price has went down from around 65 USD to around 5 USD in less than a year, reaching the lowest of 3 USD. The financial aid before this was a failure and Barclays, Citi, Merrill Lynch and other investment banks took a severe hit. There are also well renowned financial institutions with historical background and other ustable and smaller scale players who were hit and trapped.
Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt's New Deal to provide liquidity to the mortgage market. In 1968, to remove the activity of Fannie Mae from the annual balance sheet of the federal budget, it was converted into a private corporation. The main reason for the privatisation was due to the financial pressure from the war in Vietnam. Before the recent takeover, the US government does not have any stake in Fannie and Fannie was not accepting any government subsidies. Fannie continues to fulfill its duty to try to help US citizens buy their own house and was relieved from any tax burden.
Created in 1970, Freddie Mac can be seen as a measure to prevent market monopoly by Fannie Mae. It can also be seen as a way Wall Street taking the chance to share and enjoy the benefits of Fannie's preferential policies of treatment by the US government. Before the crisis, Freddie and Fannie had over 90% market share in the secondary mortgage market (with some welfare in the residential mortgage). Ginnie Mae never had the chance to catch up with Freddie or Fannie.
The capital behind Freddie and Fannie was actually very small. The ability to make it so big was because of the invisible credit support by the US government which allows Freddie and Fannie to have virtually limitless financing. Take Freddie Mac for example, in 2006 for every 10 seconds they are able to issue a mortgage loan, one of the seeds of destruction planted for the current sub-prime financial crisis. Under the US Congress special law registration, Freddie and Fannie does its job of stabalizing the mortgage market with its business under the supervision of the US federal government, and enjoying benefits and excemptions that other financial institutions can never dreamed of. The debts issued by Freddie and Fannie were not guarenteed by the US government in any contractual form. Under the current crisis situation, congress has no choice but to allow Treasury Secretary Henry Paulson to take over Freddie and Fannie's financials. As for what will become of Freddie and Fannie, it will be up to the congress and the next US government to decide.
Other then the loose management and supervision of Freddie and Fannie, the decline of the US economy and increasing jobless data were also the cause of the crisis of Freddie and Fannie. Those who cannot pay up for their homes are pitiful, but those who hold the preferred shares, normal shares of Freddie or Fannie and the management suffer even greater losses. Financial takeover is an emergency crisis aid for Freddie and Fannie, it will pay first pay the mortgage backed securities and debt holders of up to a 100 billion USD. The difference between preferred shares and debt is, those who cannot pay up the interest for debt holders will be declared bankrupt but it is not breaking of the contractual terms if the dividends cannot be paid to the share holders. There is nothing much the preferred share holders can do. The normal share holders have fled wherever and whenever possible since the crisis first started. Now is to see how the management apologize. Other than blaming the management of Freddie and Fannie, the more critical issues now are the various implications of the crisis of Freddie and Fannie and the recent bailout move. The rescue of Freddie and Fannie by the US federal government was approved by congress, but the bill will be footed by the FED and US Treasury. How much more funds can be used by the US Treasury? If the US economy continues to weaken and more default in mortgage payments, Freddie and Fannie can become 2 bottomless pits. The Bush adminstration's budget surplus basically is hopeless and cannot be depended on, a last minute increase in tax is also not possible, the only way is to issue more bonds by the US government.
Under the current circumstances, issuing of more bonds by the US government will add on to the depreciation of the USD, increasing the export and currency appreciation pressure of other countries. But if the holders of the US bonds were to reduce their holdings, it will cause the bond price to go down which will cause the bond rates to go up, adding on to the financial pressure for the US government to raise funds to the extent that the US government may be unable to issue new bonds.
With the current move, it will act to calm the holders of the securities (various countries SWFs, mostly from Asia and China) and let them hold to maturity. With the buying of the securities, it will act to stabalize the price and maybe start a round of buying of the securities. Pacific Investment Management Company (PIMCO), running the world's largest bond fund, has said that if the US government were to inject more funds to support the financial market, they and other big financial institutions will follow. With the intervention of the US government, the securities issued by Freddie and Fannie are now very low in risks, almost equivalent to the US government bonds.
The China central bank on 8 September 2008 through its official website expressed that the measures taken to alleviate the Freddie and Fannie crisis situation are positve and should be able to stabalize the market and restore confidence.
Fitch Rating's Eileen A. Fahey during an interview with a newspaper reporter says that the move by the US government may be to stabalize the mortgage market and at the same time increase liquidity in the market to lower the current mortgage spreads which is way above the historical level. Eileen also said that Freddie and Fannie now have the same level of ratings as the US government. This means that the securities issued by Freddie and Fannie will be about the same price as the US government bonds. On 7 September 2008, Standard & Poor's Ratings Services said it affirmed its long-term AAA and short-term A-1+ senior unsecured debt ratings on Fannie Mae and Freddie Mac.
An analyst mentioned that maybe too much attention has been put on the China and Asia central banks' holdings of Freddie and Fannie's securities. This gives the central banks too much extra pressure and prompts the decision makers to reduce their holdings in a hurry which at the situation at that time will be sold at a loss. The debt market liquidity is high and the sub-prime weakness is also causing the downturn of the prime maket. Although Freddie and Fannie beforehand were investing in prime market housing areas, but prime mortgage securities are also depreciating in value.
The analyst also mentioned that although the securities are depreciating in values, their ratings are still quite high. With principal guarenteed and low default rate, the possibility of unable to get back the promised interest payments is quite low. The cost of the securities will not be affected, just that currently the market price is lower than the time of purchase.
So the risks of the China and Aisa central banks with their holdings of Freddie and Fannie's securities are quite low.
The recent move has also prompted strengthening of the US dollar. This should have positive effects on the US equity market and more fund will flow towards US assets creating demand.
Latest Updates
12 September 2008
- China may cut its dollar holdings - CICC
(China Daily) -- China, which holds a fifth of its currency reserves in Fannie Mae and Freddie Mac debt, may cut the portion held in US dollars, according to China International Capital Corp (CICC), one of the nation's biggest investment banks.
The US government this week seized control of the two mortgage-finance companies, which account for almost half of the home-loan market in the world's biggest economy, to prevent defaults from crippling them. China holds up to $400 billion in the two firms' debt, CICC Chief Economist Ha Jiming said in a report Thursday."The crisis has made Chinese officials realize it's a bad idea to put all their eggs in one basket," wrote Hong Kong-based Ha. "This will likely lead to greater diversification of foreign exchange reserve investments."
China held $447.5 billion of US agency bonds as of June 2008, according to the CICC calculations using disclosures by the US Treasury. It is likely to reduce the portion of reserves in dollar assets from the current 60 percent by purchasing more non-dollar assets with new reserves, he said.
Countries in Asia have stockpiled foreign exchange reserves since the 1997-98 financial crisis to act as a cushion against a run on their exchange rates. That in turn has increased pressure on policymakers to ensure higher returns from more than $4 trillion in assets.
China will expand its investments in corporate bonds and equities, according to Ha. Treasury and agency bonds account for 50 percent and 40 percent of total dollar assets held by the central bank, he wrote.
- Fannie Mae sells 63% of record note deal in US
NEW YORK, Sept 10 - Fannie Mae said it placed 63 percent of its record US$7 billion two-year note sale on Wednesday with accounts in the United States.
The company, which was taken over along with Freddie Mac by the government on Sunday, also said it sold 12 percent of the notes to investors in Asia, 8 percent to buyers in Europe and 17 percent to others.
Fund managers were the biggest group of buyers, taking 54 percent of the new securities, followed by 27 percent to central banks.
When Fannie Mae last sold two-year notes, in a US$3 billion issue priced in July, investors in Asia were the largest buyer segment with 39 percent, followed by 33 percent to domestic investors. Central banks also led by buyer type, with 57 percent of the securities, followed by 20 percent to fund manager.
The new notes were sold at a yield premium 70 basis points higher than Treasuries. The spread narrowed to 66 basis points soon afterward, a market source said.
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