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Hank P's "Pinch" - The Fannie/Freddie Story
Former Treasury Secretary Hank Paulson has been coming out of the closet and doing some talking, He spoke on Bloomberg the other day, (Link). He was asked about the record profit of $17B at Fannie Mae in 2012. He said:
"Well, I read the Wall Street Journal and the Washington Post today, and I had to pinch myself. I could hardly believe what I was reading."
It was Paulson who officially put Fannie and Freddie (F/F) into concervatorship. That was four and half long years ago. Paulson made a bunch of critical decisions in those chaotic months. From the very beginning I wondered why he did not take F/F into bankruptcy. It would have been cleaner that way. The Treasury Department had to assume the mortgage debts of F/F. If they had not, the lights would have gone off, and they would still be off today. So that was a no-brainer. But why did Paulson not take the opportunity to blow up the equity in F/F?
Optics, and the realities of the situation probably had some sway in the decision to take F/F into concervatorship, versus a chapter filing. A bankruptcy would have been messy. The courts would have been involved. Lots of lawyers representing 10s of thousand of people who lost money. It would have been a circus.
Paulson is a smart guy. He must have looked at the $7t of F/F paper and said, "The hit starts at 5%". In his mind (and many others at the time) the estimated total F/F losses were in the $400-600b range. Hank knew that a number even remotely close to that loss would put the F/F shareholders into the waste bin of the pink sheets. So Hank kept F/F alive. The actual losses were a a more modest $160b.
As it turns out, Hank's decision with F/F is going to cost the government a fair bit of money. In addition, it's going to gum up the works for an easy transition to some new government owned mortgage finance entity during the remaining Obama years. That reality is going to piss off a whole bunch of liberals in Congress. There is a ton of money to be made or lost in this story. There is the potential for some drama - a Cyprus style raid on wealth is a potential outcome.
If there is any value in F/F, it's in the preferred stock, not the common shares. Some form of restructuring would seem to be the most logical outcome to this thorny problem. If that is the case, then the preferred shareholders will be first in line to get any value that might be left on the F/F carcass. The market is bidding up the old preferreds as if they were gold. I believe they might be the best performing stocks over the past six months.
There are two types of preferreds, $25 and $50 par value. An example of the price action for one of the $50 Preferreds, the Fannie G:
Two "bench mark" issues are the $25 par value FNM Preferred S and FNM T. The S's have had the highest daily turnover, (the volume is still is a trickle compared to listed shares). I follow the "T"s as it has proven to be a price leader. It trades rich to the other pref, and to my eyes, all the other pref (there are ~20 individual issues) chase the move of the preferred T.
Note: The "T's were issued in 2008, just five months before the F/F SHTF. Hank Paulson forced this deal. He insisted that Fannie raise additional equity. The deal was brought to the street by a syndicate lead by Merrill. 92m shares ($2.3B) of swill was pushed out the door. A significant portion of the crap ended up on regional bank's books. This trash paid one quarterly dividend, and then went deeply into the tank. This was an absolute stinker of a deal. Paulson knew F/F would hit the skids. In my book, Paulson sold this crap to widows and orphans, and he never looked back.
Based on Friday's close of $4.81, all the other pref stocks are headed higher.
F/F biggest asset at this point are the prior losses. These show up as deferred tax assets. For a company that has no prospect of future earnings, deferred tax assets have zero value. But for a company like GE, deferred tax assets are kept on the books at 100% of par. If this treatment were permitted for F/F, they would be technically solvent.
The market has established a value for the F/F common and preferred shares of approximately $5b. The current values of the preferreds are equal to:
- 18% of original par value for the $25 pref and 16% of the $50 pref.
- Approximately 30% of the past due and accrued dividends.
In other words, they're trading cheap.
In theory, (and based on some upside assumptions) F/F could operate for another five years, and they could pay back all of the money that the US Treasury has been forced to provide. If F/F were left alone, the taxpayers would get their money back, plus a very big return. As the government nut gets paid back, the value of the residual public securities should rise. While this would be a very desirable result for shareholders, it would also be a disaster for some politicians. The majority of congress wants to see F/F shut down, and a new government owned operation established.
I see no legal way to achieve the desires of congress. As F/F are profitable today, it will not be easy for them to be dissolved in a way that does not result in some consideration for existing stakeholders. If congress were to try to do that, there would be big court challenges. - I don't think it's possible to tank F/F any longer. If that were to happen, it would be a significant expropriation of private sector wealth - think Cyprus (Cubed).
To me, the oddest thing about this story is that it's the taxpayers that are going to end up paying back the F/F bailout. The deferred tax assets allows F/F to avoid paying any income taxes on their record profits. The pretax = after tax, so F/F are generating huge amounts of cash. They will use the untaxed cash to pay back the Treasury. This outcome was not considered to be even a remote possibility four years ago.
This story is far from over. When congress figures out that they are screwed, and F/F are coming back to life, there will be an effort to challenge that outcome. One way to blow up the common and preferreds would be to establish a new 'tax' on F/F. This charge would reflect the fact that F/F benefit from an implied guarantee of their liabilities. While some charge might be justified, this would be done with the sole purpose of destroying the public shareholders. A very hostile thing to do.
Notes: I've been involved with the busted Pref for years. I'm hanging on to them - I don't think the story is over. My original investment thinking was not based on a resurgence of F/F, I thought that the pref had to get settled one way or the other. When Hank P. put F/F into concervatorship (versus bankruptcy) the opportunity for some upside presented itself. So thanks Hank!
Investing in busted preferreds that trade in the 'Pinks' is very speculative business. Especially when they are "story" stocks. I believe that substantial up-and-down moves will be the norm for the pref stock. There is at least one scenario that leads to a zero value. F/F was never a suitable investment for widows and orphans - it's much less suitable today. For the average investor, this story is better avoided than played.
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I will believe the US has turned the corner when guys like Hank Paulson are doing time for treason. He is an agent of Banksteristan. That is all.
The actual losses were a a more modest $160b.
So glad to hear that.
Ahem, by what mark-to-fantasy valuation of the mortgages is that?
This is about to get interesting. FRE at current earnings level "pays back" govt in 2-3 yrs, FNM maybe a yr later.. Washington will be forced to deal with it shortly but not as confident as you it works out as well for pvt shareholders. Ironically, if FNM reverses allowance on DTAs, the net worth covenant means they'll have to borrow as much as 40-50bn from govt to sweep the equity. That puts them behind another yr or so and gives the govt a bit more breathing room.. I've heard that serious talk being given to
Combining cos into one and then stripping guarantee over 5 yrs or so at which point they don't know. I honestly believe that those in charge of this haven't thought so far ahead about the "what if" scenario of GSEs paying their borrowings down to zero as up until about 2 qtrs ago, FHFA still thought these companies would be drawing down another 100bn
If they want to maximize profits, ur preferreds are money good and they're a no brainer. With political considerations so high, handicapping a lot tougher
A-hole developed some heavy bags under his eyes.
At least some signs of unease…to be a crook is not an easy job.
Say what you want but I've been flipping FNMA for good profit all week! Nothing to hold more then a day or two though...
This is about to get interesting. FRE is closer to "paying back" taxpayer in full (2-3 yrs at 2012 earnings levels) and FNMA maybe a year later. That means noise for "dealing with it" will grow louder in short order. The DTA release is interesting not because of the inherent irony (100% of income already going to govt- does it matter if its FHA under HUD or IRS directly?)
But because the accounting rules requires com
"Optics, and the realities of the situation probably had some sway in the decision to take F/F into concervatorship, versus a chapter filing. A bankruptcy would have been messy. The courts would have been involved. Lots of lawyers representing 10s of thousand of people who lost money. It would have been a circus."
I might be kind of strange, but I thought that one of main purposes of having a Government was to have a court system as part of due process. So now the courts can't even be used? So what does that say about our current system of justice then? "...would have been a circus." Well, I guess if that describes the court system then it's probably an apt description of what we have going on overall.
Yes. The Government views its own purpose as excess, prohibitive, and needless complexity - and routes around it!
Courts and laws and process are for when it wants to stymie the efforts of little people who want to do something constructive or hold the government accountable.
When the government wants to do something, they just fukkin do it, like a boss, and stay fabulous.
Is this a great country or what?
Bruce: what's going to happen with your prefs is that Ezra Klein will start a thread on JournoList 2.0, and Krugman, Joe Wiesenthal, etc, are going to get a hold of the story and then trashtalk / excoriate the public security holders and demonize the "wealth" that they represent.
Then the new taxes will be put in place.
Aaaand it's gone.
And millions will be lead in a rousing cheer of the sublime and equitable brilliance of their dear leaders.
Bruce,
I always value your opiniions, even if Iam not in agreemenet with some of your conclusions. Concerning the non commercial realestate space. Where is the overall improvement in that space?
Most people I know are undr waterin their mortagages. some have gone the foreclosure route, Many are sitting in preforclosure houses not having paid rent in 2+ years. Congress is again encouraging home lending to those with minimum accptable credit ratings. What is it that many people are not getting?
if the majority of low pay entry level jobs are around the $10 p/h - $21k to $25k per year earnings potential, how will they afford even the currently depressed home realestate market?
Bruce you do fantastic research and work. When are you going to stop beating dead horses, and start raising a few thoroughbreds?
I realize (that) you are beholden to your bankster buddy's, but the 'box car graffiti' is getting STALE.
Every time we raise up a thoroughbred, some frozen lasagna company does a hostile takeover of our stock.
BTW, I love the graffiti. Think of the millions of dollars saved by corporations as crazy kids have taken over the job of painting rolling stock and buildings.
Status Quo> it is. Every time I see Bruce's graffiti, it reminds me of (Warren Buffetism)
It's called Too Big To Fail.
Hmmm ...
Managers want FF to take back some of its hundreds of billion$ 'assets' ... which now reside on the Fed balance sheet. FF aren't going anywhere, Bernanke would quash it.
Everything is contingent on 'Real Estate Bubble 2.0' carrying forward as it appears to be doing right now. 'Real Estate Crash 2.0' and all those preferred are worthless as is FF.
That bald headed, lying piece of shit was giving the interview from his windowless prison cell, right?
I always appreciate the observations of professionals so thanks for your posts. But I did laugh when I read "that reality is going to piss off a whole bunch of liberals in Congress". All 3 of them?
All democrats are Liberals....now add that up. 3+....=
Better check your terms, Tex.
What makes this story even more interesting is that the "political intelligence" firms will tell their special clients of the outcome before the public can act.
The IRS could still rule that the deferred taxes cannot be used, thus crippling the Preferreds. The Treasury will make this decision along with a few key people on the Senate Finance Cmte. It could go either way. They could save F/F and still screw the Pref holders. Or they could save both.
Just like the Medicare Advantage decision last week, the favorite hedge-fund contributors of the Obama Administration will get the information first and trade on it ahead of everyone else.
It's a pure gamble. I always worry about getting swung around the lamppost in a case like this. They could be spreading rumors to ramp the Prefs while the insiders get set up to short them.
I will watch from the sidelines. But its is entertaining how all DC decisions are now an opportunity for crony capitalists to use inside information.
"John McCain said [just prior to 2008] that the F/F was not guaranteed by the USG! Not only was he wrong, he was incorrect..."
That is the thing about rules, they change.
Hey Bruce, another great post. Thanks for your continued excellent input and observations.
Maybe this is a good time for Bank of America to spin off Countrywide.
The Bank of Coyote Ugly. Excellent comment on an excellent post. "Hammerin' Hank" should be getting out more...the guy didn't know his job was to save the dollar...but he sure acted like he knew. "the guy's in charge because they act in the absence of orders." the whole thing was a crazy quilt of "what the Phuck?" and "who the he'll knows." Fannie and Fred do stand out because they didn't tank the whole USA. I do find it amazing that "America couldn't wait to get on board the next housing bubble." Goes to show there really is a credit extension born every minute. Having said that I do find the term "conservatorship" an interesting choice of words. It makes it sound like you're keeping something "very precious" safe. Obviously this is not done "for zee Americans" but the Chinese and other East Asian investors in case Washington DC still prefers to live "obliviously." to be blunt "they own our ass" Mr President, Senate, House and Judiciary. Go ahead...have some fantastical scheme of "robbing the savers and workers to save the spenders and loafers." what did Darth Vader say? "you not find the emperor as forgiving as I am."
That SON OF A BITCH! AGAIN!!!???? This stupid fuck should be piked with a blunt wooden fence post! This guy is just a sick son of a bitch that no longer deserves to draw breath for the damage he has done and continues to do to the taxpayer AND the next generation of Americans.
Hank is a corrupt piece of fecal material.
It's worth reviewing the only time Hank ever got confronted by Congress:
http://dailybail.com/home/the-hammer-gets-hit-by-a-tree.html
Goldman Sachs strongly disagrees with your post, Everyman
I think we should just nationalize the whole thing. No point in having shareholders and bond holders getting a risk free guarantee from the government, but yet keep all the spoils for themselves. This was always the problem for Fannie and Freddie. Too many masters to serve.
Let he who provides the guarantees make the money.
you're kidding aren't you, they've already nationalized the economy, now they want to go back and round up a few strays?
FNM and FRE are already, de facto, part of the government. Remove the guarantee and they would be no different than private banks which means they would have to compete which means they would die a quick death. Therefore, unless the guarantee is removed, I agree that nobody at FNM and FRE should be paid more than a public serpent's wage.
I would have enjoyed this story even more, on a purely personl level, had I read about it at the beginning of the year.
Well...I have always been reluctant to come out and say this stuff way a "buy". People can get hurt with junk preferreds... but I've been hinting just that:
1/10/2013
http://www.zerohedge.com/contributed/2013-01-10/tape-tale
6/11/2012
http://www.zerohedge.com/article/best-performing-stocks-ytd-go-figure
This goes back all the way to 7/2009
http://seekingalpha.com/article/148804-agency-preferred-stocks-who-s-buy...
There are more on this topic. Google, Fannie Preferreds,Bruce Krasting
Bruce,
Thanks. As you stated, buying preferreds which are in trouble can be a very lucrative enterprise, but requries a lot of homework and monitoring. I appreciate the fact that you are careful not to light a fire.
As with most things in life, everyone, and I mean everyone, the most sophisticated among us, wants an investment that is too good to be true. Sometimes they really are, but that's where the work comes in. More often than not, a pig with lipstick is still a pig. In this case, looks like you may be onto a nice instance of government arbitrage!
Great article. Conservatorship is spelled with an "s".
In grammar school I got a D in spelling, but I got an A in busted pref...
The USG owns the mortgage market and by extension the RE industry. RE prices are simply a reflection of artificially low mortgage rates. Meanwhile, the real foundation (wages and employment) of the USG's tax base is crumbling. Something has got to give and I think that will eventually be the bond market. But who knows when. Better to step aside until the USG can no longer afford to backstop the entire credit market.
This is Soviet model - State is own everything, means of production, real estate, all wealth. Why should not United Socialist State of Amerika also do so?
*Truth actually is elite - banker, oligarch, or party technorati - is owner and master, but "The State" is easy to sell to citizenry.
Amerika, you are been POWNED!
John McCain said [just prior to 2008] that the F/F was not guaranteed by the USG! Not only was he wrong, he was incorrect...
Re one of Bruce Krasting's favourite themes, the USA and entitlement payments (excuse the OT to Bruce's excellent article above) -
American entitlements at their most spectacular -
Two people in America alive today are getting US federal payments -
Because they are children of veterans, of the US 1861-65 Civil War !
« Civil War payments are going to two children of veterans — one in North Carolina and one in Tennessee — each for $876 per year. »
The US Civil War 150 years ago ... teenagers serving in the war ... fathered children much later when over age 60 ... their children now around age 100 ...
http://www.desmoinesregister.com/viewart/20130319/NEWS/303190109/U-S-sti...
It's called Too Big To Fail.