Bill Gross Was Correct — Treasury To Take Over Fannie & Freddie

Kurt Brouwer September 6th, 2008

Given the news of late, I suppose it had to end like this for the two government-backed mortgage behemoths.  The U.S. Treasury looks set to take over both companies and put them in some form of government control.  This Bloomberg piece spells it out [emphasis added]:

Paulson To Take Over and Restructure Fannie, Freddie (Bloomberg, September 6, 2008, Dawn Kopecki and Alison Vekshin)

Treasury Secretary Henry Paulson will use his authority to rescue Fannie Mae and Freddie Mac, likely placing the beleaguered mortgage-finance companies under government control as early as this weekend.

The Treasury plans to put Fannie and Freddie into a so-called conservatorship and pump capital into the companies, House Financial Services Committee Chairman Barney Frank said in an interview after being briefed by Paulson. The government would make periodic injections of funds by buying convertible preferred shares or warrants in the companies as needed, avoiding large up- front taxpayer costs, according to a person briefed on the plan.

“This is no bailout, particularly for the shareholders,” Frank said. The federal government “will be senior to all shareholders, preferred and common.”

It is quite ironic that these two mortgage giants have been laid low by the subprime lending mess and the collapse of the bubble in home real estate prices.  Both entities were created by the Federal government to help finance the purchase of homes by Americans and to help keep the mortgage market operating smoothly.

…Fannie was created by the government in 1938 and Freddie was chartered in 1970 mainly to boost the availability of home loans and provide market stability. The companies currently own or guarantee almost half of the $12 trillion in U.S. home loans.

…Pacific Investment Management Co., manager of the world’s biggest bond fund, and other large investors may put in their own money once the Treasury decides to inject government funds, Bill Gross, co-chief investment officer at Newport Beach, California- based Pimco, said yesterday in a Bloomberg Television interview.

“They have to open their wallet,” Gross said. About 61 percent of Gross’s holdings were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or government agency Ginnie Mae, according to data on Pimco’s Web site.

As we posted back in August, Bill Gross predicted the government would have to take over Fannie and Freddie:

Pimco’s Gross Says U.S. Will Rescue Fannie, Freddie (Bloomberg, August 6, 2008, Kathleen Hays and Shannon D. Harrington)

Bill Gross, who manages the world’s biggest bond fund, said the U.S. Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie Mae and Freddie Mac to help shore up their capital.

“By the end of the third quarter, the preferred stock in Fannie and Freddie will be issued, the Treasury will have bought it,” Gross, co-chief investment officer at Pacific Investment Management Co., said today in an interview on Bloomberg Television. “We’ll be on our way toward a joint Treasury-agency combination.”

Gross adds to a growing chorus of investors and analysts predicting U.S. Treasury Secretary Henry Paulson will need to use his newly won power to prop up Freddie and Fannie. Freddie posted a second-quarter loss that was three times wider than analysts estimated and said credit losses doubled in three months, heightening concerns it may not be able to weather the worst housing slump since the Great Depression.

Freddie Chief Executive Officer Richard Syron today told investors the company will wait for its stock to improve before starting its planned $5.5 billion capital raising. Freddie agreed in May to raise the capital but failed to complete a sale as its stock slumped as much as 80 percent.

“I have enormous respect for Bill Gross,” Syron, 64, said today in an interview with CNBC. “I think he’s an extraordinarily talented manager, particularly on the fixed income side. But based on the information I have now, I do not believe that the Treasury will end up having to inject money into Freddie Mac.”

…About 61 percent of the holdings of Gross’s Pimco Total Return Fund were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or U.S. agency Ginnie Mae, according to data on Pimco’s Web site…

Turns out that Gross was right on target and the head of Freddie Mac was wrong. The government will buy the preferred stock and will no doubt guarantee the existing debt. But, those who still own common stock in the two companies have already seen their holdings decline precipitously as seen below.  It is unclear what will be left for the common shareholders after the takeover and they may be left with little more than memories.

The Bloomberg piece on the government takeover of Fannie and Freddie continues:

Washington-based Fannie and Freddie dropped in after-hours trading yesterday. Fannie fell $2.25, or 32 percent, to $4.79 at 5:50 p.m. in New York Stock Exchange trading and Freddie slumped $1.40, or 27 percent, to $3.70. Fannie is down about 66 percent since the end of June as concerns about the companies’ capital grew. Freddie has fallen about 69 percent.

Fannie’s market capitalization is now $7.6 billion, down from $38.9 billion at the end of last year. Freddie’s has fallen to $3.3 billion, from $22 billion over the same period…

It has been fascinating to see Bill Gross operate in this arena.  His fund — Pimco Total Return — has been a big buyer of government-backed bonds lately.

See also PIMCO Buys $2.5 Billion In Mortgage-Backed Bonds and Bill Gross — Stop Falling Home Prices Now.

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