HBOS versus Freddie and Fannie

The U.S. House of Representatives has passed the housing bailout bill helping troubled mortgage borrowers, but also giving the U.S. Treasury Department a blank check to support Fannie Mae and Freddie Mac. The New York Times describes it this way:

Representative Barney Frank, Democrat of Massachusetts and a primary author of the legislation, said troubled homeowners might get relief within days of Mr. Bush signing the bill, because lenders have long known details of the legislation and could move quickly to help borrowers refinance. “Many of these institutions know this is coming,” he said. “I hope they will be able to take advantage of it right away.”

But the legislation, much of which has been debated and fretted over on Capitol Hill for months, also leaves numerous questions unanswered. The biggest unknown is whether the measure will be adequate to slow the downward spiral of home prices and help the economy recover from what many analysts now expect to be a prolonged slowdown.

Perhaps most significantly, the legislation hardens the government’s long-implicit assurance that it would step in to rescue the two mortgage giants who together own or guarantee about $5.2 trillion of the nation’s $12 trillion in mortgages. Currently, Fannie Mae and Freddie Mac guarantee financing for about 80 percent of new mortgages.

To accommodate a potential rescue for Fannie Mae and Freddie Mac, the bill raises the national debt limit to $10.6 trillion, an increase of $800 billion.

The Treasury Department has said it hopes never to use the authority to spend unlimited taxpayer funds — perhaps hundreds of billions of dollars — to maintain the solvency of the mortgage giants because they are in sound financial condition. Still, shares in the two companies rose sharply on Wednesday in a sign of the market’s positive view of having a federal rescue plan in place.

NY Times, 24 Jul 2008

What I find most galling about this bailout is the taxpayer support for Fannie and Freddie. Think back to earlier in the week when a large global bank ran into problems with serious writedowns and was forced to raise capital. I’m not talking about Fannie or Freddie. I am talking about HBOS:

HBOS today revealed that take-up of the £4bn fundraising, which was unveiled on April 29, was just 8.29pc .

“The message is loud and clear: people still don’t really want to buy banking stocks,” Julian Chillingworth of Rathbone Brothers told Bloomberg.

“From an HBOS point of view, they have shored up their balance sheet and improved overall capital ratios. They have achieved what they set out to do.”

The volatile markets are likely to have played a major role in the decision to shun the rights as shares in HBOS fell to as low as 225p on Wednesday before closing at 254p as concerns about U.S. mortgage lenders Fannie Mae and Freddie Mac weighed on sentiment.

Telegraph, 21 Jul 2008

Here are Fannie and Freddie’s weakness causing market panic that pulled down the entire global banking sector, helping HBOS to the record for the largest rump of shares EVER left in UK history after a rights issue. And, what happens later that week to these two publicly traded companies? They get a massive bailout from the U.S. government.

HBOS can’t place its shares because no one wants them — in part because of the GSE’s; they must actually fear for their very existence in the event of needing more capital. Meanwhile Fannie and Freddie get a gurantee from the government that the government will supply them with unlimited capital if they can’t place their shares. Does that seem fair to you? Does that represent free market economics? I think not.

What the U.S. government must do is end the charade that these are private sector companies, beholden to the same risk of failure of other companies. They are not. Freddie and Fannie have effectively been nationalized.

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