Much of the plan is consistent with what was leaked yesterday: firing the CEOs, replacing the boards, and putting the companies into conservatorship. The details that are new today have to do with the balance sheet restructuring that will take place. Bloomberg News reports the following key elements:
- Senior preferred stock. A new class of stock will be created that earns 10% dividends and gets access to the cash from these companies ahead of any other investors. Bloomberg wrote, "Treasury will receive $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie and Freddie. The government will receive annual interest of 10 percent on the initial investments."
- Forced liquidation of mortgage holdings. The plan forces Fannie and Freddie to reduce their mortgage holdings dramatically over the next several years. Bloomberg reports, "As a condition for the assistance, Fannie and Freddie will have to reduce their holdings of mortgages and [mortgage-backed securities (MBS)]. The portfolios shall not exceed $850 billion as of December 31, 2009, and shall decline by 10 percent per year until it reaches $250 billion."
- Quarterly capital injections. Depending on the net worth of Fannie and Freddie each quarter, Treasury will purchase more senior preferred. "The Treasury will purchase up to $100 billion of senior-preferred stock in each company as needed to maintain a positive net worth. It will also provide secured short-term funding to Fannie, Freddie and 12 federal home-loan banks," according to Bloomberg.
- Open market MBS purchases. Treasury also plans to enter the market to purchase MBS. Reuters reports that it "expects to purchase $5 billion of Fannie and Freddie mortgage-backed securities within the next month."
Why will this plan spook Wall Street? It will probably wipe out common equity holders and damage the worth of preferred shareholders. And it does not make clear how much money the Treasury is actually going to commit to bailout the MBS market. Despite the weeks of buildup to this plan, the bad news is now much clearer to investors than the good news.
But perhaps the scariest part of this deal is what it reveals about the lack of credibility in the numbers that companies report to shareholders. If a third-party could come into these companies for a few weeks and conclude that the combined $84 billion in capital they reported in June was essentially worthless, then what does this say about the reported net worth of all the other financial institutions whose balance sheets are weighed down with asset-backed securities?
How much of the stated capital on the books of our largest financial institutions could be similarly wiped out after a couple of weeks of scrubbing by an independent accountant?
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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Reader Comments (Page 1 of 1)
9-07-2008 @ 5:59PM
JOHN said...
I totally disagree.
These issue have already been discounted by the market. The key is that debt holders will be secure and the future of both GSE's is now much clearer. The market will be delighted by the news.
9-07-2008 @ 10:13PM
Jeff said...
Bailout? Enhances credit held by banks and foreign investors. Can't see Treasury offering better strategy or improving operations. What has been said about creating capacity to fund future mortage origination? Hand securities creation over to Wall Street? Fair weather commitment at best from investment bankers. Devil is in the operating details - as usual.
9-08-2008 @ 6:34PM
C. W. Brashier said...
Looks like the tax payer and small stock holder will be paying the bill, personal loss as a stock holder approx $100,000.and a large ortion of my retirement income.
To add insult to injury Paulson then fired the CEO's, who really did not cause Fannie and Freddie's problems and hired two insiders from Merrill Lynch and US Bancorp who probably were part of the "GREED" that has caused this economic turmoil in the first place!