Paulson Sends Fannie and Freddie to the Rescue

Many readers will see that as an ironic title, but I don’t mean it that way. Federal regulators have directed Fannie Mae and Freddie Mac to buy $40 billion per month in troubled mortgage-backed securities – the same ones targeted by the $700 billion bailout bill. As with the Paulson plan, price is still a question mark – too low and it does no good, too high and it will create losses for Fannie and Freddie – but we see this as a positive step. Fannie and Freddie were effectively nationalized, so we can think of them as part of the Treasury department at this point. One major question about the Paulson plan is whether $700 billion is enough to have a major impact on the market. Using Fannie and Freddie to increase the overall size of the program does increase taxpayers’ potential exposure, but it also increases the chances of having a meaningful effect on confidence in the financial sector. Buying assets this way may be especially important now that it seems much of the original $700 billion will go to direct bank recapitalization – which, we think, is a better use of that money.

While this is a step in the right direction, it still smacks of the incrementalism that has dogged the government’s response to this crisis. We may have reached the point where only a general guarantee of bank obligations will do the trick.

Let us know if you see other tools that Treasury picks up to attack the problem.

2 thoughts on “Paulson Sends Fannie and Freddie to the Rescue

  1. “Fannie and Freddie were effectively nationalized, so we can think of them as part of the Treasury department at this point.”

    Are you sure of this? Shouldn´t they be part of HUD?

    Thanks.

  2. A most relevant distinction between the Paulson plan and past experiences in similar circumstances e.g. the RTC plan during the savings & loans crises, is that in past plans the bail-out bill was destined to purchase primitive assets. The current plan seems to include also some derivative assets.

    Besides their increased pricing complexity, some derivative assets were originated at prices that included substantial arrangement fees that were passed on to the borrower as a smaller initial borrowing amount. Somehow, the price at which the government buys these assets should take this into account. And I do not know how to.

    If the bail-out bill would only cover the primitive assets i.e. the mortgages themselves or some mortgage pass-throughs, it would a fairer arrangement.

    But I have one question:

    Wouldn´t it be interesting that after the purchase of the US$700 BN of tier-3 securities, the governement were to come out with an additional direct purchase of the underlying mortgages in order to guarantee their timely payment and therefore ensure a subsequent re-sale of the tier-3 securities at a profit?

    Thanks.

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