Channeling Hank Paulson, tonight the NYT inveighs against the terrible damage certain to be done to the good faith and credit of United States unless F&F are given a blank check by Congress to continue business as usual. Oh, and that check needs to come this week, thank you very much. All you pesky elected officials can drop your questions in one of the two boxes stationed outside the Treasury Department: one is labeled “Thank God you guys understand this now, cuz you didn’t then and I don’t now;” the other, “I never really was a patriot, anyway.”
http://www.nytimes.com/2008/07/21/business/21bank.html
Imagine my astonishment that I failed to move Secretary Paulson in my previous post:
http://insomniactive.wordpress.com/2008/07/19/fannie-and-freddie-should-go/,
in which I argued in agreement with Holman Jenkins of the WSJ that while–yes of course the US Government must stand behind the instruments it implicitly guaranteed–an actual bailout of the F&F entities themselves with either taxpayer money or an open market equity sale makes no sense.
Let’s back up once again to recall the progression of events leading to the spastic-goat rodeo at which we are now shame-faced and reluctant spectators. Fannie was created in a retrospectively inspiered act of New Deal desperation in 1938. The idea was that the US Government would stand behind Fannie’s mortgage loans in order to jump start the moribund housing market. Three decades later, having both served and outlived its intended purpose, Fannie was spun off as a private entity which later became publicly traded. Two years after that, when it was clear that things were going so well that Fannie actually needed competition, Freddie was born with the same quasi-guarantee strand of DNA. It went public in 1989.
Fast forward nearly 20 years. Whatever was the logic for a taxpayer-backstopped entity owned by a tiny fraction of the taxpayers, that fraction was extremely grateful. At its peak in 2004, the combined market cap of the two companies was nearly $150 billion, and compensation of the respective CEOs crossed into 8 figures without decimal points. The benefits to actual homebuyers who availed themselves of Fannie and Freddie loans are the matter of some controversy. But the two entities were incented to write, buy, and package loans. Management did all three with increasing abandon, even as the warning lights on the housing market began to blink:
http://insomniactive.wordpress.com/2008/07/16/pick-me-for-ceo-of-freddie-mac/
With nothing as a competitive advantage other than an implied guarantee by the US taxpayer, Fred and Fan competed, competed, competed; the housing market got moist, wet, positively liquid; shareholders and management got rich as millionaires, Major League shortstops, doges. Then, alsa, asset values dropped by the most since the Great Depression, and open flew the kennel containing the Hell Hounds of the Implied Guarantee.
It all reminds me about what Pat Buchanan said recently about conservatism:
Every great cause becomes a movement; every movement becomes a business, and every business becomes a racket
But I digress. With the hounds braying and his back against the wall, on Sunday Hammerin’ Hank vaguely remembered a recent situation involving another money-thingy named after the mascot of a football team from his beloved Chicago. “Too big to fail,” cried Secretary Paulson just in time this morning, to any talking head with ears.
“You’re danmed straight” chorused the indignant sovereign entities who had taken on 20% of Fannie’s paper as an alternative to U S Treasurys because that’s sorta how it works in some Asian markets, or at least so says the NYT. Not that said sovereign entities were additionally cranky about the trajectory of their other dollar-denominated assets. Nothing so petty as that.
My other favorite line from the NYT article:
Also at stake is Americans’ future ability to gain access to credit. If foreign companies and governments abandon United States investments, home, auto and credit card loans will be much more difficult to come by.
Ya think!? Much more difficult than not having to provide a down payment or any financial information to get a mortgage? The horror! What happened to life, liberty, and the pursuit of below market debt, funded by other nations but guaranteed by…..uh, us? We Americans DEMAND better than that, which may have something to do with the fact that our national savings rate has gone from 8% to a goose egg in 40 years.
Sigh.
Here is what the US Government must do: it must make good on its implicit guarantee of the security of the paper F&F peddled. This, even though the implicit-ness of said guarantee makes me think of a deal where all the venture capitalists point at one of their syndicate partners and say, “I thought you did the reference checks” when the CEO and his admin drain the checking account and head to a balmy island without an extradition treaty.
Here is what it must not do: make any accomodation to shareholders or management in the process. Whereas the sanctitiy of the paper must be preserved, the entities themselves must be restructured entirely, with an eye toward having them go away–entirely, as well. Management must go, and shareholders must be at the very back of the line.
I know I’m ignoring all kinds of details and unintended consequences. But, sweet trident of Poseidon! “Too big to fail?” Is there a more slippery slope? This is a chance, as Jenkins wrote last week, to put two anachronistic albatrosses out of our misery. And in the bargain, we can make the bold statement to our trading partners that we care more about their debt on which we overpromised than about the F&F common shareholders who paid their money and took their chances.
There is a bright side. This should be the perfect job for a lame-duck administration historically low approval ratings. After all, how much worse can it get? But don’t ask Paulson that. He was John Ehrlichman’s right hand in the Nixon administration.
Get The Economist’s take here:
http://www.economist.com/finance/displaystory.cfm?story_id=11751139
