Monday, July 14, 2008

WSJ: Paulson Drove GSE Rescue Plan

by Bill McBride on 7/14/2008 08:48:00 PM

From Deborah Solomon and Sudeep Reddy at the WSJ: Paulson Drove Plan to Shore Up Fannie, Freddie

The WSJ reports that about two weeks ago Paulson ordered his staff to draw up contingency plans in case Freddie or Fannie faltered. When that planning was leaked in a WSJ article last Thursday, equity investors realized that any bailout plan would seriously dilute their holdings, and this led to more selling of Fannie and Freddie. Apparently Paulson believed this selling forced his hand.

There really are no specifics to the plan. The increase in the Fannie and Freddie lines of credit with the Treasury will be "increased to an unspecified level to be determined by the government later".

And any possible equity investment is unclear. The WSJ quotes Brian Bethune, Chief U.S. Financial Economist for research firm Global Insight as saying the equity investment could be as high as $20 billion. That would seriously dilute existing shareholders.

And on the Fed:

Once Treasury made it clear there was a plan, the Fed decided it could offer Fannie Mae and Freddie Mac access to its lending facility, known as the discount window, but purely as a backstop. It was a move that could happen right away without congressional approval.
The Fed views this as a bridge line of credit just until Congress approves the Paulson plan.

It seems the plan is bad for equity holders, but good for debt holders ... and potentially bad for taxpayers (like the Bear Stearns bailout). However Professor Hamilton thinks there will be a limit set on the losses by taxpayers, and the remaining losses will fall on creditors:
... such action by Congress would take the form of a dollar limit-- here's how much we're willing to stake, and no more-- with residual losses presumably laid on the GSE creditors.
Maybe, but I don't see that in the plan.

The WSJ article shows how quickly this rescue plan came together; basically another ad hoc move by the government. Let's hope this plan work out better than the Super SIV / MLEC.