Regional US Banks are Heavily Invested in Fannie and Freddie Preferreds

This may help to understand the Treasury's next moves.

The banksters really do not want Fannie and Freddie to be bailed out and maintained in anything such as their current form. They want Fannie and Freddie's business, more precisely the fees from same. They also want the debt to be made whole.

The big banks do not care so much about the preferred stock. In fact, they might even be in favor of a haircut there, to set up some bargains for the coming wave of bank consolidations. But the Fed doesn't like it, because they see the domino risk to the system.

Again, this might help to explain the solutions that comes out of Washington and New York. There is significant maneuvering behind the scenes by the vested interests. Of course then there are the Democrats. Hank has a window of opportunity to settle the GSE's hash before he loses his grip on power. Let's see what happens.

Fannie and Freddie threat to banks
By Saskia Scholtes in New York and James Politi
The Financial Times
August 23 2008 03:00

Small regional US banks could face substantial writedowns if the government has to rescue Fannie Mae and Freddie Mac, the two giant US mortgage financiers.

Regional banks, together with US insurers, hold the majority of Fannie and Freddie's $36bn of outstanding preferred stock, which could be wiped out in the event of a government rescue.

Few banks have taken any writedowns on the preferred shares, which have lost more than half of their value since June 30. This could exacerbate the impact of losses on the preferred shares at a time when many banks are experiencing losses on residential construction loans and home equity portfolios.

Tom Priore, chief executive of Institutional Credit Partners, a boutique investment bank, said: "If the government takes a senior preferred stake, it will crystallise existing losses for the banks and add to them in a way that damages local lenders at a time when they can least afford it."

Fannie and Freddie's preferred stock ratings were cut by Moody's yesterday from A to Baa3. Moody's said the cut reflected the uncertainty surrounding how these securities would be treated if the US Treasury provided Fannie or Freddie with support and the reduced financial flexibility the two companies would have in the event of a Treasury intervention.

The rating agency said it saw the odds of such an intervention as increasingly likely, pushing Fannie and Freddie's stock prices down by a further 14.5 per cent and 8.25 per cent, respectively. Both stocks have lost more than 40 per cent of their market value this week on fears that government intervention is imminent.

"Given the GSEs more limited ability to raise capital and grow their portfolio to accomplish their public policy role in a time of mortgage market turmoil, we believe that there's an increased probability of actual support coming from the US Treasury," said Brian Harris, analyst at Moody's.

The Treasury was granted powers last month to extend its credit lines to Fannie and Freddie and invest in their debt and equity, but it has not given any further clarity on the structure a rescue for the companies might take.

Many analysts believe the most likely option is for the government to get preferred shares as part of any rescue, eliminating the value of common shares, and ranking higher than existing preferred shareholders, who will probably see their dividends cut.

Philadelphia-based Sovereign bank said this week it holds more than $600m in preferred stock issued by Fannie Mae and Freddie Mac, representing 0.78 per cent of its total assets.

Analysts at CreditSights said a full write-off of Sovereign's preferred stock in Fannie and Freddie could represent as much as four quarters of earnings. Sovereign executives warned there was a possibility they could take a significant writedown in the third quarter.

The Fed's Fatal Attraction with Wall Street Is a Source of Policy Error

Link to Buiter's Complete Paper Presented at Jackson Hole

Fed Attention to Wall Street `Dangerous,' Buiter Says
By John Fraher and Scott Lanman
Bloomberg News

Aug. 23 (Bloomberg) -- The Federal Reserve pays a ``dangerous'' amount of attention to the concerns of Wall Street, constraining its ability to influence the economy, former Bank of England policy maker Willem Buiter said.

``The Fed listens to Wall Street and believes what it hears,'' Buiter said today in a paper presented to the U.S. central bank's annual symposium in Jackson Hole, Wyoming. ``This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous.''

The central bank has drawn criticism from some officials in the U.S. and Europe by trying to end the yearlong credit crisis through an expansion of lending. The steepest interest-rate cuts in two decades risk stoking inflation, while the Fed has been too generous in aiding banks, Buiter said.

In addition to rescuing Bear Stearns Cos. from bankruptcy, the Fed created a program to swap Treasuries for mortgage bonds, opened up lending to Wall Street firms and reduced the premium for direct loans to commercial banks.

Buiter, a founding member of the Bank of England's independent rate-setting board in 1997, said the Fed's behavior over the past year represents an example of ``regulatory capture.'' In such a relationship, policy makers take on ``as if by osmosis, the objectives, interests and perception of reality of the vested interest they are meant to regulate and supervise in the public interest,'' he said.

Heated Debate

Buiter's paper sparked the most heated debate of any item on the two-day conference agenda. Bank of Israel Governor Stanley Fischer opened the question-and-answer session by holding up a fire extinguisher and saying, ``I asked the organizers for some technical assistance in dealing with this discussion.''

Former Fed Vice Chairman Alan Blinder said that the central bank's performance, while not flawless, has been ``pretty good under the circumstances.''

Fed Governor Frederic Mishkin, one the strongest advocates of the ``risk management'' approach to financial crises, said after Buiter's presentation ``there are a lot of unguided missiles that have been shot off.''

Under Bernanke and his predecessor, Alan Greenspan, the Fed has cut rates in response to falling stock prices more than is justified to safeguard economic growth, Buiter said. On Jan. 22, as global stock markets tumbled, the Fed slashed its overnight lending rate by 75 basis points.

Safeguard Economy

Bernanke has argued that policy makers' actions were necessary to safeguard the economy from the impact of the credit crisis. Greenspan engineered rate cuts in 2001 through 2003 at a time when joblessness climbed in the aftermath of the recession seven years ago. The Fed by law is mandated to achieve stable prices and maximize employment.

Buiter also criticized the Fed and other central banks around the world for not providing more information about the valuation of collateral they accept from banks.

Such information would allay concerns financial institutions will use public funds to subsidize financial institutions, he said. This is ``most acute'' in the case of some of the Fed's emergency lending programs created in the past year.

Two economists echoed Buiter's concern in another paper presented today, saying the Fed's program allowing institutions to swap Treasuries for mortgage bonds and other debt enables firms to ``window dress'' their balance sheets.

`Deception Easier'

``Financial institutions can hold low-quality securities for the period where no reporting is required,'' wrote Franklin Allen of the University of Pennsylvania and the University of Frankfurt's Elena Carletti. ``Temporarily increasing the supply of Treasuries makes this kind of deception easier. It helps remove market and regulator discipline.''

The financial crisis is also forcing the European Central Bank to rethink aspects of its money market operations, which provide a flexibility that has been favorably compared with programs at the Fed and the Bank of England.

The ECB plans to tighten collateral rules to head off the risk of abuse by some financial institutions, ECB council member Yves Mersch said in an interview today.

Buiter won some praise for openly confronting the Fed's record at its summer retreat in the Teton Mountains.

``Willem's papers don't pull punches, they have attitude,'' Blinder said. ``You have to give credit to a guy with the nerve to come here with black bears on the outside and the FOMC on the inside and be this critical of the Federal Reserve.''

China Expects Adequate Compensation for the Failure of Freddie and Fannie .... Or Else

A very crystal clear 'suggestion' indeed. Back your markers or its game over.

Freddie, Fannie Failure Could Be World `Catastrophe,' Yu Says
By Kevin Hamlin

Aug. 22 (Bloomberg) -- A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank.

``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''

Freddie and Fannie shares touched 20-year lows yesterday on speculation that a government bailout will leave the stocks worthless. Treasury Secretary Henry Paulson won approval from the U.S. Congress last month to pump unlimited amounts of capital into the companies in an emergency.

China's $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong. The Chinese government probably holds the bulk of that amount, according to McCormack.

Industrial & Commercial Bank of China yesterday reported a $2.7 billion holding. Bank of China Ltd. may have $20 billion, according to CLSA Ltd., the Hong Kong-based investment banking arm of France's Credit Agricole SA. CLSA puts the exposure of the six biggest Chinese banks at $30 billion.

`Beyond Imagination'

``The seriousness of such failures could be beyond the stretch of people's imagination,'' said Yu, a professor at the Institute of World Economics & Politics at the Chinese Academy of Social Sciences in Beijing. He didn't explain why he held that view.

China's government hasn't commented on Fannie and Freddie.

Yu is ``influential'' among government officials and investors and has discussed economic issues with Premier Wen Jiabao this year, said Shen Minggao, a former Citigroup Inc. economist in Beijing, now an economist at business magazine Caijing.

Investor confidence in Fannie and Freddie has dwindled on speculation that government intervention is inevitable. Washington-based Fannie has fallen 88 percent this year, while Freddie of McLean, Virginia, has slumped 91 percent.

Paulson got the power to make purchases of the two companies' debt or equity in legislation enacted July 30 that was aimed at shoring up confidence in the businesses. He has said the Treasury doesn't expect to use that authority.

The two companies combined account for more than half of the $12 trillion U.S. mortgage market.

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