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Saturday, September 06, 2008

Federal Government Bailout of Fannie Mae & Freddie Mac

Fannie Mae and Freddie Mac employees and other stockholders are the real victims of the collapse of these two behemoths. Of course, employees may only have themselves to blame if they put all of their faith in the companies and did not diversify their retirement stock portfolios. Our guess is that many did not because, from our intimate personal knowledge, the employees thought the companies were bullet proof. And why not when the stock was at $80 and there was always the implied backing of the federal government. Unfortunately, what they are learning the hard way is that the federal government was not backing their stocks. Now employees who were calculating their retirement based on stock bought at $10 and $20 and feeling great about it being $80, are now faced with holding worthless paper. Of course, other stockholders who did not get out in time will also take significant losses. The government might make some sort of arrangement for shareholders though during the takeover process. Regardless, it is a tragedy almost unbelievable in its swiftness and indescribable in its pain.

Federal officials have informed top executives of Fannie Mae and Freddie Mac that the government is placing the two companies under federal control. The plan places the companies into a conservatorship that operates like a pre-packaged bankruptcy. It is similar to plans used by small businesses to clean up their books and then they can emerge with stronger balance sheets. The executives and their boards are being replaced and shareholders have lost their stock value. The companies will still be allowed to continue with uninterrupted operation because the government is backing their debt. Fannie and Freddie are responsible for nearly 70 percent of new loans. This bailout has the potential to cost taxpayers trillions of dollars. It will clearly be the largest rescue in the nation’s history.

The debt securities Fannie and Freddie issue to finance their operations are owned by mutual funds, pension funds, foreign governments and big companies. The declines in the housing and financial markets forced the administration’s hand. Foreign governments had become increasingly cautious about holding billions of dollars in securities issued by the companies, particularly with no sign that their losses would abate any time soon. This situation combined with the inability of the companies to raise new capital, the administration apparently decided it would be better to act. Fannie and Freddie have about $5 trillion in debt outstanding that is being held by investors including Asian central banks. Payment of this debt is now guaranteed by the federal government. (The New York Times, 9/6/08)

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