The Fannie-Freddie Frenzy: Pros Chime In

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The most important point is there is no imminent threat of default. They are not banks and not subject to runs. Most of the mortgages they hold or have guaranteed are good quality prime conventional mortgages. Their accounting difficulties limited their buying and guaranteeing activities in 2006 and 2007, so they participated little in the worst vintages of mortgages. The default rate on F&F mortgages is low, and income stream from them is currently adequate to meet F&F current expenses. Unlike some other financial institutions, F&F don't have liquidity problems, but they do have significant solvency problems.

Eric Wasserstrom and Robert Peruzzi, CFA, investment research analysts at UBS (UBS):

Although the GSEs had to this point demonstrated no difficulty in raising liquidity, we believe this announcement mitigates liquidity concerns. FRE is conducting a discount note auction today. If the Treasury elects to pursue an equity stake in FNM or FRE, we believe it will do so in the form of a long-dated convertible preferred security. This implies significant common dilution, but is likely supportive of securities above common stock in the capital structure, and gives the GSEs an opportunity to mitigate the dilution through earnings.

We think today's events ensure liquidity for the GSEs, but we remain concerned about dilution until more is known regarding a possible equity injection. Also, given the Fed's long-standing criticism about GSE capital levels, its new consultative role may imply permanently higher levels of capital.

We view Fannie Mae and Freddie Mac's risk as moderate because their implied government guarantees give them the financial capacity to carefully hedge risks while still generating high returns to shareholders. Key risks to our valuation are 1) political: Congress eliminates or weakens the value of their charters; 2) credit: a prolonged national real estate recession; 3) interest rate: a rapid rise in interest rates of 300 bps or more.

Peter Cohan, president of Peter S. Cohan & Associates, on Bloggingstocks.com:

Investors in Fannie Mae and Freddie Mac must be applauding the government bailout. To my knowledge, it is unprecedented for the government to trade this openly in the stock of a private company. It is as if the government has become Goldman Sachs Group (GS), which is not surprising, since the Treasury Secretary, Hank Paulson, used to run Goldman.

Based on what has happened, it looks to me like the Administration is trying to prove just how incompetent government is so we will agree to cut its budget. There are two possibilities: Either the government knew how bad things were and did nothing, or it didn't know. If it did know how bad things were, it should have done something to fix the problem, such as requiring Fannie and Freddie to raise more capital a year or two ago.

Perhaps it knew last week how bad things are and did not release data supporting its claim that they were in good shape because such data did not exist. If they were in good shape, the government should have been able to release comforting data and the problem would have gone away. The need to announce the bailout plan as a way to save them suggests an amazing lack of insight into their ability to cover their liabilities years or a realization that they were bankrupt and needed to be bailed out.

If it did not know how bad things were, that's even more shocking. In either case—it knew and did nothing or it didn't know—the government is exhibiting gross dereliction of duty. But I think its incompetence is demonstrating the need for really capable and empowered regulators. I am hoping America will realize how important regulation is for the effective operations of a free-market economy.

Heidi Moore on The Wall Street Journal's Deal Journal blog:

When it comes to Fannie Mae and Freddie Mac, we have to ask: It is appropriate for regulators to question moral hazard, but shouldn't they also aim those questions of accountability at the consistently bumbling management of the two lenders—which held an implicit government guarantee—rather than shareholders?

After all, it doesn't seem a very strong defense for the government to say, "You should have known better than to have confidence in Fannie Mae and Freddie Mac." The government's involvement was precisely why any shareholder would have faith in Fannie and Freddie. They are, after all, "government-sponsored entities," or GSEs. Paulson used the term—but did not define it—in his statement yesterday.

Consider the uncomfortable truth here: Shareholders bought shares of Fannie and Freddie precisely because they knew that if the two lenders ever fell in trouble, the government would step in. And now that the government has stepped in, it is determined not to help shareholders, saying they should have known better. Well, did the government know better? And if so, why didn't it take action earlier?

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