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Letter to New FHFA Director - A Proposal to Swap REO for Agency Preferred Stock

Bruce Krasting's picture




 

Dear Mr. DeMarco,

Let me welcome you to your new responsibilities. You have a very
important job. There are a significant number of people in the
financial world who lie awake at night worrying about the mortgage
lenders you are responsible for.

Fannie Mae, Freddie Mac and the FHLBs
hold or guaranty $6.3 Trillion in residential mortgages. It is simply
not possible for the US to get out of the mess we are in unless these
Agencies are stabilized. Should those Agencies fail, all that has been
done to heal the US financial sector will have been wasted. In a
significant manner, your success or failure will determine the medium
term course of the US economy. Given that the USA is still the driver
of global economic activity I would extend that albatross on you as
well. If you do not succeed the rest of the global economy will suffer.

You need to do things differently than your predecessor. You
need to be aggressive in addressing the Agency's problems. You need to
find new solutions, you need to be creative.

Would you like to
sell up to $60 billion of your Real Estate Owned (“REO” )? This would
be a critical step. If you were able to sell these properties at a
reasonable price it would reduce the problem significantly. If you sold
the properties rather than auction them off you would be helping to
protect the value of homes in neighborhoods across the country. The
auction process just devalues the nearby homes and results in more
defaults. We need a plan to address this negative cycle.

Would
you like to address and resolve the problem you face with the Preferred
Shares that both Fannie and Freddie have outstanding? These shares are
an impediment to a restructuring of the Agencies. While you may be able
to let the common shareholders blow in the wind it is not likely that
you can take this attitude regarding the public Preferred holders. My proposal:

Agency Preferred Stock Swap for REO
(discussion draft)

Parties to the Transaction:
(A) Fannie Mae and Freddie Mac as the “Sellers”or the “Agencies”.

(B) Private sector individuals and Corporations who are owners of the Preferred Shares of the Agencies (the “Purchasers”).

Sale Pricing:
Individual
properties will be made available to Purchaser(s) at a price equal to the
sum of (i) The outstanding principal loan balance plus (ii) 100% of
past due and accrued interest on the loan plus (iii) 10% of the
outstanding loan principal balance (the “Purchase Price”).

Treatment of Unpaid and Outstanding Property Taxes:

The
Purchasers must come to the closing with cash in an amount equal to
100% of the outstanding property taxes. These funds will be remitted
directly to the appropriate municipal tax authorities.

Purchase Terms:
The
Purchasers can satisfy the Purchase Price by tendering Preferred Shares
of the Agencies. The par value of the Preferred Shares will be the
basis of determining the number of shares required to consummate the
purchase. Example: If the Purchase Price is $250,000, then 10,000
shares of $25 par value Preferreds are required. Alternatively 5,000 of
$50 Preferreds are required. (the “Tendered Preferred”).

Treatment of Cumulative Dividends on the Tendered Preferred:

Any unpaid or accumulated dividends on the Tendered Preferred will be forgiven.

Minimum Holding Period of the Purchased Properties:
The
Purchasers will agree to retain ownership in the Purchased properties
for a period of 24 months commencing from the date of closing.

Penalty for Early Sale:

If
a sale of a Property is consummated prior to the 24-month restriction a
penalty of 20% of the sale price will be assessed at the closing (the
“Early Sale Penalty”). This penalty amount will be paid to the
Municipality in which the property is located.

This type of
transaction would solve the Agency Preferred share problem. It would
result in the sale of a very substantial amount of the REO on your
books. It would do it without loss to the Agencies. It would resolve
the back tax problem that is hurting communities and ultimately will
hurt the Agencies. It would recycle these properties back into the
private sector where they belong. The lockup provisions would insure
that the properties are not back on the market for an extended period
of time. This proposal would create liquidity and increased value for
the outstanding Preferred shares. As you know, the Nation's regional
banks hold a significant amount of these shares. Creating liquidity and
enhanced value would help restore bank balance sheets.

I wish
you well in your new job. We are all rooting for your success. Market
based solutions are the only approaches that will work. Please give
market based thinking some consideration. That would be well received.
It would be a refreshing departure from all of the non-market solutions
that D.C. is pursuing.

Bruce Krasting

Disclosure:
I own Agency Pref. Some I acquired before they went into
conservatorship last year. These shares are trading at 10-15% of their
original issue price. I am deep under water on those buys. I bought
some more a few months ago in a double down desperado move. If
something happened along the lines I describe above I might break even.
That would suit me fine. The outcome will not impact me in a material way, regardless of the outcome. I think that this
transaction concept could make everyone a winner. Comments more than
welcome on this one.

 

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Sat, 09/05/2009 - 09:28 | 59795 Anonymous
Anonymous's picture

looks like you stirred a hornets nest bruce. i liked the letter.

...marathon man

Wed, 09/02/2009 - 23:57 | 57092 Lionhead
Lionhead's picture

Isn't the problem here all related to the haircut given to the preferred shares by the gov't by coming in and arbitrarily wiping out the value of these shares in the takeover of the GSE's? If so, then the existing rules on BK & contracts kick in. Team BO has the attitude they can do "whatever it takes" on any given situation to "fix" it overnite.

Bruce K, I feel for you and the millions of retired folks who bought these shares under the pretext of the quasi gov't guarantee now proven worthless. You have commited the mortal sin of doubling down on a losing investment. You know better...

I have zero mortgage exposure, nor do want any as the next shoe in CRE will be dropping soon compounding the RE problems. RE is fast money for a quick trade only. I suspect that the funds being formed now will be marketed to retail investors who will purchase this paper and spread this manure out to the sheeple. No thanks Blackrock, et al...

Wed, 09/02/2009 - 22:30 | 57056 Anonymous
Anonymous's picture

You say it in your article and you said it again in your comments. Your major mistake is that you are arguing that price discovery is lowering the value of homes. That is not the case. The value of homes is being lowered because they are unaffordable and unsustainable. Nothing can fix this but time and the market. Sorry if that conflicts with your own interests, but I suggest you re-work those interests to reflect the inevitable.

Tue, 09/01/2009 - 22:49 | 55783 Bruce Krasting
Bruce Krasting's picture

JBR,

My instinct is that it is actually you that is commenting on this. If so, thanks for taking the time. I can handle the criticism.

I agree with you that all the players in the game will suffer and that they deserve that. Put that is my point. This is a trash for trash swap. If there is a way forward it will because the trash from the past is swept up. This idea just encourages the process.

A friendly wager, 500 Sing dollars. In one year or less the issue of the Agency Pref wil be on the table. A swap of this paper for something (maybe bad RE, or bad common stock).

I tried to make it clear that I am not a paper jockey. Sorry you did not sense that.

Bruce Krasting

 

 

 

Tue, 09/01/2009 - 21:33 | 55712 James Beeland R...
James Beeland Rogers Jr.'s picture

Its not just that your plan is ridiculous, I don't come to ZeroHedge to hear paper jockey's talk their book. 

You and I are both on the hook in that we are taxpayers. Yes, I still pay taxes while raising my girls in Singapore. But I didn't seek out additional exposure to these entities by buying up their paper.

The notion that your plan "saves money" of anybody in the capital structure is misguided as all of the creditors deserve the haircut they will eventually get. The GSEs were unconstitutional and investing in them was foolhardy.

Capitalism and the efficient allocation of capital need rule of law. 

Unfortunately, rule of law no longer reigns in the US.

Best,

Jim Rogers

Wed, 09/02/2009 - 04:11 | 55909 Project Mayhem
Project Mayhem's picture

I mean it's pretty obvious Bruce is not a paper jockey -- he disclosed clear as day this trash was on his book.  He was asking for opinions on the idea I think.   I don't understand it well enough to comment intelligently, only to ask questions. 

Tue, 09/01/2009 - 19:59 | 55647 Anonymous
Anonymous's picture

You can't do this on a blanket level across the country each city in every state has a different set of laws for foreclosoure. Also, who gets the best properties and who gets the worst ones? Who sets the fair value? As an investor in this company you are done, you failed the first rule of investing, don't put all your eggs in one basket. If you owned a ton of paper for the juicy yield and it has wiped you out, your greed led you there. The way to work off the inventory is to give all buyers of the a foreclosed house a giant one time $10,000 tax break and you will get the buyers out in force.

Tue, 09/01/2009 - 18:22 | 55544 Bruce Krasting
Bruce Krasting's picture

Juno9604:

You ask what about the people living in the house. I am referring to properties that have been foreclosed on (REO). They are empty. There is no one living in them. The prior owners either got kicked out or sent in the keys.

So now this house is empty. I am sure that you have houses like this not too far from where you live. They are in every community in America. They drag down values of other nearby homes.

This plan reverses that. It gets the properties out of foreclosure and with a new owner. And it does not cost us to achieve that.

Tue, 09/01/2009 - 18:15 | 55538 Bruce Krasting
Bruce Krasting's picture

I did not have to disclose my conflict on this. There are no rules. I did that because I thought it was the right thing to do. If you believe that, then believe that the amounts involved are peanuts and that has nothing to do with my writing this.

I don't think that China and Japan are the big holders of this. They own the MBS of the Agencies. Pref would not have qualified as a Reserve. It does not matter who owns it. There is a market for it every day on the NYSE.

The Agencies have REO correct? When they dump this they will take a loss, correct? When they take a loss the tax payer pays, correct? That is you. That is me. This plan would elimate the loss. I am trying to save you a few bucks. This plan does not take money out of your pocket and it fixes a big problem. Show me something that is out there today that does that. Everything is costing you. Except this.

No one seems to have done the math on this. Look again. In this deal one can get $25 of buying power for $2. That is the best deal ever. That is too rich. But it shows how much room there is when you swap a $25 preferred that can be bought for $2.

In bankruptcy the courts always swap equity for real assets. That is all this does. It discloses that both the loans and the preferred are not worth their stated amounts.

I maintain my view. This IS a market based approach

 

 

Tue, 09/01/2009 - 17:08 | 55463 Anonymous
Anonymous's picture

I agree with Jim Rogers...this is a stupid idea...to answer the question of who owns the preferred...look no further than the top holders China and Japan. Once again a short term fix that has long term, sovereign consequences with the real loser being the U.S. taxpayer and anymore with a mortgage.

Bankruptcy is the answer. Let the free market work. Values need to come down, to match the decline in wages and lost wealth. Homes will become affordable for more Americans, that will stabilize the economy.

Maybe Mr. Krasting didn't hear about China's most recent take on contracts...if they are owned by the state of China, contracts can be null and void when they decide it benefits their interest. This could be devastating...

http://www.businessworld.ie/livenews.htm?a=2470412

Tue, 09/01/2009 - 13:04 | 55147 Project Mayhem
Project Mayhem's picture

I'm yeah let me say I don't understand the details , but I thought the letter was good.  Maybe someone can explain what the implications are of swapping agency preferred for real estate.  Who owns the preferred besides Bruce?  Is it legal to do this? What are precedents for doing it?  How does this effect GSE debt (if at all)?

 

What about the fact that much of Fannie and Freddie paper is fraudulent (same house is in multiple CDOs etc)... how does this effect the idea? 

Tue, 09/01/2009 - 16:56 | 55449 Neo of Zion
Neo of Zion's picture

If I understand the CDO fraud properly, this tender could never happen. Same reason many banks cannot modify mortgages - too may stakeholders own the paper and nothing gets done.

 

Tue, 09/01/2009 - 12:48 | 55129 juno9604
juno9604's picture

Where do the homeowners go?

Tue, 09/01/2009 - 12:25 | 55097 James Beeland R...
James Beeland Rogers Jr.'s picture

Directly swapping agency preferred paper for real estate is delivering American sovereignty on a silver plate. Refer to the overseas plurality of agency holders.

 

This is a ridiculous idea. The author is talking his book.Booo this man!

 

Why not allow price discovery, default, bakruptcy and rule of law to reign?

 

 

Wed, 09/02/2009 - 11:32 | 55732 vanquished (not verified)
Tue, 09/01/2009 - 16:11 | 55374 ratava
ratava's picture

price discovery, default, bakruptcy and rule of law

 

sir, are you a muslim socialist nazi commie nigerian terrorist who wants to kill my grandma by any chance?

Tue, 09/01/2009 - 10:26 | 54949 Project Mayhem
Project Mayhem's picture

Good letter

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