During the political conventions of the past few weeks we heard both Barack Obama in Denver and John McCain in St. Paul lay out their solutions to some of the financial problems facing this country. While this was going on, a financial problem of seismic proportions was looming in the background.
On Sunday, the government took over Fannie Mae and Freddie Mac, leaving over 100 billion dollars in losses for common and preferred stockholders, with some banks included among their number. This bailout move can further drive down the price of those shares if the government exercises its warrants, giving it the right to a stake of 79.9% of each company for a nominal sum. Common shareholders are expected to see the value of their investment, which have already fallen, shrivel further - to around $1.
The bailout is especially problematic for some of the banks that hold Fannie and Freddie preferred and common shares. It will be interesting, as this situation develops, to learn how many banks are holding shares and how much this has impacted the banks' capital reserve requirements. Will they have to come up with rescue plans of their own to backfill their capital requirements? This may push the deposit rates (both High-Yield Savings and CD rates, for example) higher. If so, how will this impact mortgage rates?
The ripple effects could cause the bailout to end up being more expensive for taxpayers and private enterprise than most forecasters comprehend. What do you think? I look forward to hearing your thoughts.
Monday, September 8, 2008
Fannie Mae and Freddie Mac Takeover: The Fallout
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3 comments:
It maybe problematic for some banks and their capital reserve requirements. What do you think of the CDSs and debt dilemma. Aren't those going to affect the financial markets?
Thank you for your comment: I am currently working on a post about CDSs, which will hopefully answer your question!
I think the takeover of Fannie Mae and Freddie Mac is inevitable. The alternative is much worse. I think the immediate fallout of this is that mortgage rates will rise. In the past Freddie and Fannie were able to buy loans from banks and repackage them with a guarantee and resell it at a rate that is probably much lower than the risk associated with the underlying asset. It's an financial illusion (or trickery) which gave us home owners unbelievably low interest rates. The government couldn't fully let that illusion dissipate since it would create a much deeper financial crisis and had to preserve it as much as it could. Now it's time for reality to set in and therefore, mortgage rates to rise.
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