Fed Pushes Fannie, Freddie Shareholders in Front of Train
Bailout to hit investors hard.
Small banks will see large chunks of capital wiped out from equity losses in Fannie and Freddie - but they can now get in line for the government dole.
In seizing the embattled mortgage giants, the Treasury Department shoved common shareholders in front of the train, reaffirming they'd bear the brunt of future losses. As with the Bear Stearns takeover, the Federal Reserve and the Treasury dealt with the moral hazards of risky investments by simply punishing common shareholders and bailing out debtholders.
The countless financial institutions holding Fannie and Freddie preferred stock must now act as the second line of defense for the money of our trading partners, allies and certain well-connected institutional bond investors.
Preferred shareholders have no voting rights, but they stand in front of common shareholders in terms of dividend payments and the right to recover their investments in the event of liquidation. There had been speculation that Washington would go easy on preferred holders and protect their dividends, and, by extension, the value of preferred shares. Since most holders of these assets were other financial institutions, the logic went, the Treasury wouldn't put undue stress on an already troubled group.
The Treasury's bailout plan doesn't protect preferred shareholders, as evidenced by the steep drop in the value of those shares today. However, various financial regulators are prepared to step in and assist small banks with significant exposure to Fannie or Freddie via investments in preferred shares.
FDIC chairman Sheila Bair tried to diffuse the situation by claiming that "Across the industry, banks do not have significant exposure to GSE equity securities." But since the FDIC also neglected to include collapsed mortgage thrift IndyMac on its list of potentially troubled financial institutions just weeks before it went bust, her assertion shouldn't carry much weight.
Sovereign Bank (SOV) isn't likely to be comforted by Bair's soothing words either, as losses on the bank's Fannie and Freddie preferred stock could erase almost a year's worth of earnings, according to analysts at Credit Insights. JPMorgan (JPM) is also likely lose money on similar holdings, although even if it's entire $1.2 billion investment is wiped out, the hit would represent less than 1% of its tangible capital.
Capitalist ideals go right out the window during times of crisis. Unprecedented financial calamities result in unprecedented government intervention.
It's anybody's guess as to how long it will be before markets are allowed to find a true bottom, to experience true price discovery and thus establish a true foundation for recovery. Until then, investors should try to relish being a part of some of the most historic financial events in the past 80 years, while preserving capital for the inevitable opportunities that lie on the ever-elusive other side of the abyss.
The information on this website solely reflects the analysis of or opin=
=3D =3D3D ion about the performance of securities and financial markets by =
the wr=3D iter=3D3D s whose articles appear on the site. The views expresse=
d by the wri=3D ters are=3D3D not necessarily the views of Minyanville Medi=
a, Inc. or members=3D of its man=3D3D agement. Nothing contained on the web=
site is intended to con=3D stitute a recom=3D3D mendation or advice address=
ed to an individual investor =3D or category of inve=3D3D stors to purchase=
, sell or hold any security, or to =3D take any action with re=3D3D spect t=
o the prospective movement of the securit=3D ies markets or to solicit t=3D=
3D he purchase or sale of any security. Any inv=3D estment decisions must b=
e made =3D3D by the reader either individually or in =3D consultation with =
his or her invest=3D3D ment professional. Minyanville write=3D rs and staff=
may trade or hold position=3D3D s in securities that are discuss=3D ed in =
articles appearing on the website. Wr=3D3D iters of articles are requir=3D =
ed to disclose whether they have a position in =3D3D any stock or fund disc=
us=3D sed in an article, but are not permitted to disclos=3D3D e the size o=
r direct=3D ion of the position. Nothing on this website is intende=3D3D d =
to solicit bus=3D iness of any kind for a writer's business or fund. Mi=
ny=3D3D anville mana=3D gement and staff as well as contributing writers wi=
ll not respo=3D3D nd to em=3D ails or other communications requesting inves=
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter