Financials in Trouble, Part 2-Minyanville

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Financials in Trouble, Part 2

John Mauldin Aug 25, 2008 10:15 am


		Bank failures could total $850 billion.

The basic problem is this: Without Freddie and Fannie, the mortgage market would go from crippled to moribund, if not dead. We've created a system that couldn't function without them, and the cost of allowing them to collapse would be another 1930s-style Depression - the era in which these firms were first created.

They were never designed to take on the huge leverage they did, nor to use hundreds of millions in lobbyists' money and campaign contributions to create a massive payment scheme for management and shareholders. Congressional estimates are that this could cost US taxpayers $25 billion, a significant multiple of their current market caps.

Fannie and Freddie won't be able to raise capital on their own. At this point, why would any rational investor put that much money into a company with such a convoluted preferred share scheme, without government guarantees?

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That estimated loss assumes that the housing market won't get any worse. But it could - or things could get better. Who knows? Why invest in something with so much uncertainty?

But there are more problems. You can’t just take someone else’s property -- and stock is indeed property -- without some excellent reasons. You're therefore almost forced to wait for a crisis - otherwise shareholders will sue, saying they suffered unnecessary losses.

You can certainly expect the preferred shareholders to sue. That's why Paulson hired JPMorgan (JPM) to figure out how to recapitalize the banks. I don’t envy the people working on that one. Maybe there's some magic somewhere, but as we saw with Bear Stearns, at the end of the day it is all about adequate capital.

The GSEs should be adequately capitalized and broken up into much smaller firms that wouldn't be "too big too fail." These should then be put under a regulator that would enforce reasonable leverage limits, with profits going to pay back the US taxpayer before any profits or dividends are paid to any other future owners.

That is, if the government takes the 2 GSEs and puts capital (probably in the form of loans and guarantees) into them, which puts taxpayers at risk, then allows a public offering of the smaller entities to raise capital to repay the loans, any shortfall should be made up by the issuance of preferred shares. The common shareowners would wait until the government loan was repaid before they would be eligible for a dividend.

And the people responsible for creating the leveraged systems (the board, et al.) should be forced to resign. New top management all around.

The ultimate goal should be for taxpayers to get their money back and any guarantee, implicit or explicit, to be removed. No mortgage bank should ever again be allowed to be too big too fail.

Now, taken as a part of the total credit crisis, which will run to over $1 trillion (at least), $25 billion may not seem like a lot. But I hope this is a wake-up call for better regulations and safeguards.

And I will reiterate my call for regulators to force banks to move their credit default swaps to an exchange. The potential for a blow-up is serious, and it could dwarf the current credit crisis. I'm not saying it will happen, just that it could.

Even a low-risk event should be protected against. Credit default swaps are legitimate business transactions. They're very useful, but should just be put on an exchange, like futures or options, where there's 100% transparency as to counterparty risk.


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Gina Nye

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08-26-2008, 5:35 pm
I have one question what would happen to treasury yelds if they nationalize that pair of white elephants? i have a feeling that the us AAA rating would rapidly go to hell in the hand basket Read More


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