I Don't Understand...
Fall 2008 Brookings Panel on Economic Activity

John Hempton on Frannie

Let me, for one, endorse pretty much everything he says:

Bronte Capital: The Reality Based Community and Frannie: I estimated the earnings power of Fannie Mae at about 10 billion per annum. Fannie has something near a trillion in debt... at 130bps over treasuries... Fannie had nearly no [net] earnings power... [with] losses in the book... around 80 billion.... The Government might have solved this problem by explicitly guaranteeing the debt and leaving the private ownership in place.... I would have thought the implicit guarantee was enough – but [the] 130bps [spreads] tell me it wasn’t.... Over the next couple of years then Frannie was effectively going to raise over a trillion dollars in US government debt.... [If] spreads [stay] 100bps or more... [the] cost to the Federal government of delay is... 10-20 billion annually....

The logical thing for the government to do in that circumstance is not delay. [The alternative is to cross your fingers and hope that the debt spreads on Frannie debt dropped to 30bps on their own accord.] My understanding of US politics (erroneous it seems) suggested to me that this administration would not want to explicitly socialise the problem. Moreover many decisions of this administration are best described by delay and crossed fingers. So I am staggered by rapid logical action. But so be it and for once I think a Bush administration action is sensible.

But I am more staggered that the market forced the action. I thought that the market would see the implicit guarantee for what it was and trade Frannie senior debt at low spreads. But reality has the ability to get in the way of many things.... This must really pain the Republicans... reality got in the way of ideology.

There is a second hard decision – which is what to do with the preferred. Any solution that leaves the preferreds as senior to the Government capital would indicate that the Republicans have dumped ideology entirely. I am not sure that they should wipe out the preferreds – but I would have a jaundiced view of any deal which substantially pays the preferreds before the government makes a reasonable profit on the capital that they are putting it risk.

As I said, when I do the numbers the outstanding preferreds look good. There's $10B or so of annual earning power in Fannie if it can borrow at Treasury rates--as long as the economy as a whole doesn't go deep down the toilet.