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Treasury Secretary Henry Paulson announced this morning (Sept. 7) the long-expected news: the government will take over mortgage behemoths Fannie Mae and Freddie Mac, which together own or guarantee $5 trillion of U.S. home mortgages, half the total. The chief executives will leave after an interim period. There was no word whether they would be investigated; news came out late yesterday that government auditors have discovered accounting irregularities that may have led to an overstatement of capital. Fannie and Freddie have long been undercapitalized. Investors always assumed that these government-sponsored entities would be taken over by the U.S. in a crisis. Hence, risk was not a major factor: Fannie and Freddie could borrow at below-market rates and lend at above-market returns. Capital was therefore inadequate, and now it appears this thin capital may have been overstated. The takeover was timed to be announced before Asian markets open this evening. This was the same strategy in the takeover of Wall Street's Bear Stearns earlier this year. Yet government officials say with a straight face that their decisions are not based on stock market reaction. As in the move to have Bear Stearns taken over by JP Morgan, the government argues that Fannie and Freddie are too interconnected with the global financial system to be permitted to fail. Current stockholders of the companies won't see their shares canceled, but if too much goverment money is poured into the rescue, share values could be erased.

Comments
29

So by being patient (i.e. Brandes) you will be ok and make great returns. WRONG! BIP shareholders will now be wiped out in this! Common shareholders are getting nothing. This is exactly my point why buy and hold value investing is dead.

I am sure investors are happy to be paying Mercedes type fees for these type of stock choices. Pzena and Legg Mason blew it here also.

COLT

Sept. 7, 2008

Reform, who are you kidding Don.

Did reform come with the Bear Stern's bailout?????

Here is a good read-right up our ally on Wall Street nonsense; http://www.washingtonpost.com/wp-dyn/content/article/2008/09/04/AR2008090403191.html?sub=AR

Sept. 7, 2008

Reply to #2

So many people have been burned by the corruption on Wall Street that they now vow to never ever return. Do you realize how many nest eggs have been cut in half?

Too much greed has caused International investors to view the U.S. as a scam market. Ask someone savvy in Europe or Asia.

COLT

Sept. 7, 2008

Well, I guess this was to be expected, even if has been dreaded for a while now. If I understand correctly, banks that have a large stake in either GSE will also be taken care of by the Fed and Treasury. It gives a new perspective to the old adage "if you owe the bank a thousand bucks, the bank owns you; if you owe the bank a million bucks, you own the bank": we can add to that now "if the bank owes a billion bucks, it owns the government". The banking crooks must already be taking numbers on those lounging chairs at exotic beaches in far-off tax havens.

Sept. 7, 2008

Response to post #1: As I understand it at this early stage, common shareholders of Fannie and Freddie won't be wiped out unless the government has to throw a huge amount of money at this calamity. However, it's almost certain that the government will throw in much more than it now pretends to anticipate. Your observations have been on the money. Best, Don Bauder

Sept. 7, 2008

Response to post #2: That Washington Post column is great. I wish I had written it. Best, Don Bauder

Sept. 7, 2008

Response to post #3: Good point. Wall Street has lost tremendous credibility. However, since it's Wall Street and others in investment banking that do 85 percent of the trading, Wall Street doesn't give a damn about its public image. Best, Don Bauder

Sept. 7, 2008

Response to post #4: It's my understanding this early in the game that the U.S. will back up Fannie and Freddie fixed income instruments. If they crashed, financial institutions throughout the world would come asunder. I understand the same is true with F & F preferred stocks. So many banks use them as reserves that it would be a disaster to wipe them out. This is the old question of moral hazard. Investors used these F & F instruments because they thought they were as safe as Treasury paper, even though they were theoretically private enterprises. Best, Don Bauder

Sept. 7, 2008

Response to post #9: The Fannie/Freddie bailout is another case of socialism for the rich, capitalism for the poor, or socialization of the risk and privatization of the gain. It's more corporate welfare for the nabobs who keep talking about free enterprise, free markets, rugged individualism, and the horrors of regulation. The stock market is zooming this morning -- obviously, because the government is picking up the risk. You ask: how long can this go on? It can go on until the election, perhaps much longer. Best, Don Bauder

Sept. 8, 2008

Response to post #8:

Reading your columns and columns referred to in your Blogs Don leads one to the conclusion that all of our institutions such as the City of San Diego, Wall Street, Main Street, the Treasury, Congress, White House etc. are all "as safe as Treasury paper" which is to say they are all worthless, or soon to be worthless.

Under these conditions, the most important question that remains to be answered is How Long Can This Go On before "valueinvestingisdead" because as the WP column said "This is an industry that has lost all credibility -- with investors, with corporate clients and with the public" along with your reality check "Wall Street doesn't give a damn about its public image" and the fundamental failure mode fact being that Washington doesn't give a damn about its public image either except once every four years, maybe?

How Long Can This Go On?

Sept. 8, 2008

The fact that the DJIA is up 3 digits this morning tells me that either nobody was counting on Fannie/Freddie dividends in the stocking this holiday season, or that smart people swapped their stock for Fannie/Freddie debt, knowing eventually that the taxpayers would make good on them when those bonds matured.

If none of the above, then maybe NORGAS because of this giant JANFU being too big for anybody in her or his right mind being able to comprehend it all.

Sept. 8, 2008

I think this "bailing out" money has to come from somewhere, and doesn't that mean more inflation?

Don, have you seen the documentary I.O.U.S.A.? I haveb't yet, but I'm curious if it's worth seeing.

Sept. 8, 2008

Response to post #9: Your use of the word "perhaps" is a most important, it needs a bit more quantification because this is most certainly a "giant JANFU" indeed because the credit credibility of our ultimate backup Treasury has to be at grave risk already and getting graver.

You'll be sure to let us know when it's time to start taking Mandarin lessons won't you Don, so we can ask for more credit from the new owners of the Treasury after they foreclose?

Sept. 8, 2008

Response to post #24: Many financial institutions worldwide use Fannie/Freddie paper as reserves. Yes, there could be some real problems if the value of these fixed and preferred assets fall. It is interesting how the media played the Fannie/Freddie story as a positive for the U.S. Positive? Maybe for the stock market on the short run. Best, Don Bauder

Sept. 8, 2008

The dollar, almost worthless. I hear Europe is calling the dollar the "American Ruble" and might not take the dollar as currency anymore.... (OK that was a joke).

We just keeping printing money like it was toilet paper-and that is going to be the ultimate value very soon.

Sept. 8, 2008

Don, have you seen the documentary I.O.U.S.A.? I haveb't yet, but I'm curious if it's worth seeing.

http://www.iousathemovie.com/

Sept. 8, 2008

Believe it or not, the CEOs of FNM and FRE are going to get millions in severance. Run a company into the ground and get millions!

Insane!

Sept. 8, 2008

Response to post #25: We certainly need equitability. Best, Don Bauder

Sept. 8, 2008

Response to post #11:In my judgment, the market zoomed today because the federal government was taking risk off the private sector. As I have said before, this is called corporate socialism. You'll notice that, in particular, bank stocks soared; the notion is that fewer mortgages will be at risk, interest rates will go down, etc. Also, there is the old story of moral hazard. If the U.S. will bail out Fannie and Freddie, it will also bail out Lehman and other biggies that are already on the brink, the thinking goes. Remember, the market made a substantial recovery after the Federal Reserve saved Wall Street's bacon in March by giving Bear Stearns to JP Morgan. This is the kind of thing you can expect in an election year. However, next year, the new president will face a deficit of $500 billion or more. At some point, this corporate welfare will run out of gas because of the ballooning of the federal deficit. Today, though, was one of euphoria, and it may last up through the election. My guess is that the timing of this takeover was plotted for the election. Best, Don Bauder

Sept. 8, 2008

Response to post #12: Yes, the swelling of the federal deficit will lead to inflation, in all probability. The fed will have to print money to cover the deficit. I have not seen the movie yet. Is out on DVD? Best, Don Bauder

Sept. 8, 2008

Response to post #13: The U.S. won't be declaring BK any time soon. Best, Don Bauder

Sept. 8, 2008

Response to post #14: The dollar, which has recovered to a certain extent -- but has still been cut in half against major currencies -- will eventually go down again. It may take some time. Best, Don Bauder

Sept. 8, 2008

Response to post #15: I haven't seen it yet. I respect those who put it together. When it lashes entitlements, I hope that it points out that corporate welfare is a far bigger problem monetarily than social welfare. Best, Don Bauder

Sept. 8, 2008

Here is the web site for the film:

http://www.iousathemovie.com/

Sept. 8, 2008

Response to post #16: Yes, Mudd of Fannie gets $9.3 million for leaving and Syron of Freddie gets $14.1 million. Ain't life grand? Best, Don Bauder

Sept. 8, 2008

The euphoria on Wall Street today is probably going to be shortlived (at least in my humble opinion): the FDIC says there are 117 banks on the "set to fail" list (up from 61 a year ago), but I would not be surprised there will be a lot more banks than that failing. The question will be how many, how big, and how quickly in succession of each other? Lehman is already in trouble, WaMu is not doing stellar either and those are just the tip of the iceberg. The FDIC can take some over, but its pockets are not bottomless either. Quite a number of banks are also ready for a shock when they realize that their shares in the GSE's may be worthless by now. I'm sure a lot of economists, government officials and bankers will talk about free market enterprise and liberally slap Adam Smith's "Wealth of Nations" (who would have read that stuff anyways?) around. If they had read the book, they would realize it deals with "enterprise to the benefit of both trading partners" (the only way to get an economy to grow equitably) and not the zero-sum economics that Wall Street and the Fed seem to be involved in.

Sept. 8, 2008

"If they had read the book, they would realize it deals with "enterprise to the benefit of both trading partners" (the only way to get an economy to grow equitably)....."

Is that quote actually in the book?? I like it.

We need to apply that concept to the USA trade imbalance and deficits.

Sept. 8, 2008

Response to #25: JohnnyVegas - it's not a verbatim quote, but a concept elaborated throughout some of the chapters. I remember that Smith's book was summarized that way by one of my professors during accounting class (which I did not exactly do stellar on during finals). I'll dig up my copy and try to find how it was phrased exactly (Smith's sentences can be laboriously long in sometimes).

Sept. 8, 2008

Response to post #26: There are a lot of things that people will claim that Smith said in Wealth of Nations that he did not say. Best, Don Bauder

Sept. 8, 2008

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