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Saving Fannie, Freddie to Cost Arm, Leg, Firstborn Child


Bailing out GSEs has far-reaching consequences.

Creating for-profit companies that hit up Uncle Sam whenever they need money has given us the Fannie Mae (FNM) and Freddie Mac (FRE) follies.
Fannie and Freddie are the nation's 2 largest government-sponsored enterprises (GSEs). Home mortgages are poured through GSEs into the marketplace.
The market has pounded Fannie and Freddie's stock, and they don't appear to be as well capitalized as supporters would have us believe. If they were, the Treasury Secretary wouldn't be seeking a blank check to enable the government to prop them up.
Still, it's impossible to imagine allowing Fannie and Freddie to fail. But adding their losses to the government's books doesn't look like such a hot idea.
Nevertheless, the government's backing of Fannie and Freddie tells the market that Uncle Sam will pony up to keep them more or less solvent and in business. But the potential losses are so high that a full government bailout would probably be politically impossible. This creates a Catch-22 for investors: If the feds won't guarantee Fannie and Freddie, any private investment would probably be money down the rabbit hole.
There's been some movement in the company's preferred stock and subordinated debt, suggesting that Wall Street sees some type of government bailout ahead. This won't improve the prospects of first-time home buyers securing a loan, but it could provide fat profits for shrewd investors.
Barron's reports that the Treasury's move to recapitalize Fannie and Freddie could wipe out existing shareholders. Preferred shareholders and holders of subordinated debt would also suffer losses.
The Federal Housing Finance Agency, the new regulator for the mortgage giants, has been directed to raise more capital. If the GSEs are unable to raise fresh capital, the Bush Administration is expected to launch its own recapitalization effort with taxpayer money.

The equity infusion would be nationalization in all but name. But it wouldn't require putting the agencies' liabilities on Uncle Sam's books - a good thing politically, because it would about double US debt.
Rule of thumb: With government investment comes government control, creating the potential for trouble by elected officials with little or no market experience.
Congressional meddling in the mortgage market could create a bigger mess than Social Security -- and the retirement fund can't survive in its current form without stiff tax hikes, lower benefits -- or both. Bet on some retirees being required to work past 65 to receive full benefits, such as they are, or will be in the future.
It's almost enough to make an investment in Elvis plates look shrewd, even if that plug on late-night cable TV warns that the manufacturer can't guarantee that the $29.95 gems (plus shipping and handling) will increase in value.
No positions in stocks mentioned.
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