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U.S. Bailout for Mortgage Giants

Published on September 7, 2008

U.S. Bailout for Mortgage Giants

September 7, 2008

The U.S. government plans to put government sponsored mortgage finance companies Fannie Mae and Freddie Mac under federal control, the New York Timesand Washington Post newspapers reported late Friday, in what could be the largest financial bailout in the nation’s history. According to the same report, Analysts at Citigroup, Merrill Lynch, and Goldman Sachs since mid-August have issued reports saying the companies had plenty of capital to operate for the near term, and both companies have successfully rolled over debt on schedule in the meantime. Also wasn’t it just a few weeks ago when both said they had plenty of capital? Welcome to Wall Street!

The two government sponsored enterprises (GSEs) own or guarantee almost half of the country’s $12 trillion in outstanding home mortgage debt. The value of the company’s common stock would be diluted but not wiped out, while the holdings of other securities, including company debt and preferred shares, would be protected by the government, the Washington Post said. Isn’t that equivalent to bankruptcy I mentioned in Dec last year, from shareholder’s perspective.

The plan, which would place the companies into a conservatorship, was outlined in separate meetings with the chief executives at the office of the companies’ new regulator. The executives were told that, under the plan, they and their boards would be replaced and shareholders would be virtually wiped out, but that the companies would be able to continue functioning with the government generally standing behind their debt, people briefed on the discussions said.

The executives were told that the government had been planning to announce the decision as early as Sunday, before the Asian markets reopen, the officials said.

Was this the reason behind a sharp u-turn, massive 200 points recovery, on Friday afternoon (something similar happened few months back when Fed had announced another massive bail-out plan)… We’re likely to see a large stock market rally on this news on Monday, But mind this, in spite of the bail-out plans if rally doesn’t happen, too bad for the markets.

After stock markets closed on Friday, the shares of Fannie (FNM) and Freddie (FRE) plummeted. Fannie was trading around $5.50, down from $70 a year ago. Freddie was trading at about $4, down from about $65 a year ago.

Read more interesting conversation and comments on this issue here.

Profitable trading, OP

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