Secretary of the Treasury Henry Paulson announced over the weekend that Fannie Mae and Freddie Mac are being placed into conservatorship. The government is injecting capital into the entities and assuming responsibility for the senior debt. It also receiving warrants in both entities. The status of the common and preferred shareholders is tenuous, and it is highly unlikely that they will receive much in the end.
The equity markets have received this news with euphoria and are up substantially across the board. Everyone appears to be hoping that this move breaks the logjam that is currently affecting the credit markets. They are also anticipating that this move will help to stabilize the housing market.
I believe that this move will accomplish both of these objectives in the short term. The current situation could not continue without a potential financial meltdown occurring. In essence, the government had no choice but to take these steps. One can argue over the exact details but not over the actual move itself.
However, this is only a step in the process. It addresses part of a larger problem. It is similar to the bailout of Bear Stearns and the extension of credit to the investment banks. This means that there are probably more potential landmines down the road which the Federal Reserve and the government will eventually need to address.
This is just piecemeal relief to the problem. The underlying issues endangering our financial system will not disappear with this action on the GSEs. The current situation requires a reform and restructuring of our financial system, something which is substantially larger than this bailout. Previous examples include the use of the Resolution Trust Corporation in the late 1980's and early 1990's and the Swedish Banking Crisis of the 1990's. Because this is global in nature, it may also require cooperation from other central banks and foreign governments.
This is helping to stabilize the patient's condition, but it will not be a cure. This situation will not be resolved overnight under any scenario. There appears to be a tradeoff between taking the pain quickly and spreading it over a long time. We are selecting the latter. The sooner that we address with the entire problem, the closer we will be to a true long-term solution.
Doug Roberts is the Founder and Chief Investment Strategist for ChannelCapitalResearch.com, and is the author of Follow the Fed® to Investment Success: The Effortless Strategy for Beating Wall. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.
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