The Fannie-Freddie Frenzy: Pros Chime In

Here, a compilation of various reactions from Wall Street strategists, economists, and key financial bloggers

Following the July 13 announcement of a government bailout for beleaguered mortgage finance giants Fannie Mae (FNM) and Freddie Mac (FRE), Wall Street pros and the leading lights of the financial blogosphere have begun to debate what the move means, who deserves the blame for the current mess, and what the future looks like for the two government-sponsored enterprises (GSEs).

What's next for the shell-shocked GSEs, the markets, and the economy? BusinessWeek contributor Jacob Stokes compiled some rather pointed reactions from Wall Street strategists, economists, and key financial bloggers (read BW Chief Economist Michael Mandel's take):

Marc Chandler, global head of currency strategy at Brown Brothers Harriman:

The most important development today is the U.S. Treasury and Federal Reserve's action on Fannie Mae and Freddie Mac, which will either finance or back about half of the U.S. mortgage market. Treasury Secretary Paulson indicated he will seek congressional approval to 1) extend the existing credit line of about $2.25 billion and 2) seek temporary authority to buy stakes in both of the GSEs. For its part, the Federal Reserve will in effect create a new facility so that they can borrow from the Fed at the discount rate and will be given a greater say over the expansion of their balance sheets.

Even though Congress is for all practical purposes in a lame-duck mode, it is likely that the Treasury's request will be added to existing legislation pending and will be approved. In terms of how long the temporary authority is for, the initial thinking is that it could be for 18 months. These actions are thought to be preemptive in nature and to demonstrate support for these important institutions. The hope is that these actions in and of themselves will bolster market confidence without actually having to draw on the new facilities. If the Fed actually were to lend to Fannie and Freddie for anything but the shortest of terms, it would need to be sterilized (offset) through the sales of U.S. Treasury securities. Currently the Fed's Treasury holdings (under the System Open Market Account—SOMA) are valued at about $480 billion (vs. almost $800 billion a year ago). If the Fed needs more than what is available in SOMA, the Fed's ability to control the overnight rates would be reduced.

Andrew Schiff, investment consultant and director of communications for Euro Pacific Capital:

Now that the federal government and the Federal Reserve (which for reasons of honesty and expediency should simply be redesignated as an office of the Treasury Dept.) have announced a bailout of Fannie Mae, and Freddie Mac, the question becomes what is the net effect.… Maybe investors will begin to worry when another bailout isn't necessarily good news? But what happens when the reality of hundreds of billions of new federal liabilities sinks in? Simple answer: higher interest rates and a weaker economy.

A federal bailout of the GSEs will result in a serious degradation of its credit quality. The Treasury's AAA rating should, and will, be questioned. The federal government will then have to offer higher rates to attract investors, especially from the foreign purchases whose participation in the Treasury market is vital.… Given the fragility of the economy and its dependence on cheap credit, higher rates will be the final blow that sends the U.S. into a severe recession.

In choosing to support the collapsing real estate market with a dose of new inflation, the government is keeping home prices from falling further by pushing up prices for everything else. Despite the move, a real estate price collapse is inevitable. So prepare for a dollar collapse and soaring consumer goods prices as the direct consequences of this "bailout." In the end, even those getting the bailout, holders of Freddie and Fannie insured mortgages, will lose, as the value of the dollars in which these bonds are denominated go up in smoke.

Paul Kedrosky on the Infectious Greed blog:

The proposal…has now been announced, and the Administration wants Congress to take it up immediately as part of the current housing bailout package.

So, is it enough? It depends on what you mean by "enough." It will let the market know that the U.S. government is going to let Fannie/Freddie fail, but the market knew that already. Or at least it should have. Beyond that it's awfully hard to say, because markets will mostly read in this what they want to: Bulls will see the U.S. backstopping things, and bears will say the last plank just fell out of the U.S. economy and Dow 8,000 is straight ahead.

These are tough times, folks, and we're headed to a whole new place that has never been explored.

Leigh Skene, a consultant with Lombard Street Research:

Having finally emerged from their accounting problems earlier this year, Fannie Mae and Freddie Mac (F&F), the American giant lenders and guarantors of mortgages, are in the headlines once again. The prices of their common stocks have plunged by 85% and 88% from their highs last summer to yield 10.6% and 12.5% respectively. Clearly markets believe they are in trouble. The questions are, "How much trouble?" and "What does it mean?"