Friday, July 11, 2008

Conservatorship for Fannie or Freddie?

by Calculated Risk on 7/11/2008 12:54:00 AM

Two articles ...

From the WSJ: Mortgage Giants Face Pressure Over Capital

Even as federal officials sought to reassure investors about the financial health of Fannie Mae and Freddie Mac, pressure mounted on the giant mortgage companies to raise fresh capital to offset the tumbling values of home loans they hold.
...
One possible scenario if Fannie and Freddie's financial position worsens: Under existing law, if either company were severely low on capital, it could fall under the control of their government regulator, which would then be responsible for the firm. That step -- known as placing it in a conservatorship -- would allow the mortgage company to continue operating, but the extent of its abilities in such a distressed situation remains unclear.
From the NY Times: U.S. Weighs Takeover of Two Mortgage Giants
Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday.
...
Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.

The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.
Guaranteeing the debt of Fannie and Freddie would not double the public debt because they have somewhat offsetting assets. This would lower the borrowing costs for Fannie and Freddie and is probably the most effective solution (if one is needed). Its not clear to me how a conservatorship helps. Pretty scary discussion ...